Bitcoin – Should You Get In?

Bitcoin - Should You Get In?

Bitcoin – Should You Get In?

Bitcoin and cryptocurrencies are receiving significant attention lately. I've noticed an increase in emails and calls from clients about this subject. Below is a summary of the key issues related to Bitcoin and cryptocurrencies. Firstly, I'll provide background information. After that, we'll address whether you should get in.

What is Bitcoin?

Bitcoin is one of approximately 4,000 cryptocurrencies in existence. It was the first cryptocurrency and consequently, it is the most popular in the crypto space. Cryptocurrency is a digital asset. Encryption secures the digital assets on the networks on which they reside. Blockchain technology is a key component of cryptocurrencies. Therefore, transactions validate on the network without middlemen. Intead of central banks, large computer networks hold the cryptocurrency. As a result, cryptocurrency is outside the authority of central banks and governments.

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Despite the word coin, it only exists electronically on computer networks. Like traditional currencies, you have to exchange dollars to Bitcoin. Sites like CoinBase, Binance, and Kraken will handle the exchange. Bitcoin mining involves fast computers using large amounts of electricity. Miners receive cryptocurrency when the computers can solve increasingly complicated math problems.

Most people don't have the expertise and resources to succesfully mine. Instead, many people trade dollars for Bitcoin and hope for the price to rise. Increasingly, there are more businesses accepting payment every day. Moreover, many large financial institutions are beginning to create funds that invest in a wide variety of cryptocurrency. For example, instead of a mutual fund investing in stocks, it will invest in cryptocurrency.

Is It Right For Me?

Hype makes it difficult to stay focussed. Sticking to the fundamentals when allocating our funds is key. Therefore, we need to examine the following. Firstly, determine your investment objective. In other words, are you looking for growth or income from your portfolio? Or, is your goal to preserve your capital and improve tax efficiency? Secondly, you need to evaluate your tolerance for risk. That is to say, how comfortable are you seeing the value of your investment fluctuate? Lastly, identifying your time horizon is a must. For example, when will you need the funds? In short, specifying your investment objective, risk tolerance, and time horizon is the first step before making an investment of any kind. This is critical when planning your retirement.

Resisting the hype around any investment can be difficult. After all, everyone at work is talking about it. Every article you see online says you have to have it. Most importantly, email newsletters predicting financial armageddon seem to be endless. If you can step back and tune out the noise, you'll be in a better position to make sound investment decisions.

Improve Portfolio Diversification

Adding an alternative asset to a portfolio can improve diversification. For example, we can achieve diversification by investing in various stocks and bonds via mutual funds or ETFs. Rather than investing in one stock and one bond, you can increase diversification by investing in several stocks and bonds. To clarify, diversication is the process of not putting all of your eggs into one basket. If you add another asset class (cryptocurrencies), you are creating more baskets for your eggs. Having said that, alternatives shouldn't account for more than 10% of your total portfolio.

Is Bitcoin A Hedge Against Inflation?

Bitcoin

Bitcoin

As more and more dollars flood the financial system, there are growing concerns about inflation. Some have claimed the American Rescue Plan Act of 2021 will lead to inflation. If the inflation rate gets above 4% and the Federal Reserve can't control it, the value of the dollar will drop. In other words, it will take more dollars to purchase goods and services. If that occurs without a corresponding rise in income, that will have a negative effect on consumers and hurt the broader economy.

As investors, we must remember that a certain level of inflation is actually a good thing. Without it, the value of assets wouldn't rise. Inflation becomes problematic when it gets out of control. The last time that happened was in the late 1970s. In addition, the last round of monetary stimulus (Quantative Easing) by the Federal Reserve was from 2009 through 2014. Inflation hawks made claim after claim it would lead to out of control inflation and the dollar would become worthless. That never happened. I'm not suggesting we ignore or dismiss the possibility of inflation becoming a problem. Just be cautious of those who claim it's a foregone conclusion.

Many claim Bitcoin and other cryptocurrencies are a hedge against inflation. I believe the jury is still out on that one. Cryptocurrency hasn't been around long enough to be tested in an inflationary environment. I acknowledge that crypto isn't subject government manipulation in the form of money printing like traditional currencies. However, that alone doesn't make it an inflation hedge.

Cybersecurity and Fraud Concerns

Unlike traditional financial institutions, there isn't much regulation. Some might see that as a positive. However, if a firm handling your Bitcoin goes bankrupt or fails, your assets could go down with it. What if your crypto goes missing in a security breach? Where do you go to file a claim? Unfortunately, you're likely on your own. Most traditional financial firms have certain protections in place for consumers. For example, Federal Deposit Insurance Corporation or FDIC protects your deposits if your bank fails. Securities Investor Protection Corporation or SIPC protects your investments if your brokerage firm fails. To be sure, this protects you if the broker fails or goes bankrupt. It does not protect you if your investment drops in value or becomes worthless.

Proceed With Caution

There is no doubt that the gaining popularity of Bitcoin and other cryptocurrencies present opportunities. I don't believe it's appropriate to be dismissive or fearful of these new currencies. Likewise, blindly investing money without careful study and planning is a recipe for disaster. Investing isn't gambling. Investing isn't speculation. You have worked hard for your money. Make investments based on your goals and your situation. Do your best to resist the fear of missing out. Try to tune out the noise and doom and gloom about the country's finances. Above all, never invest on emotion.

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