Tales from the 'Crypt-ocurrency'

Cryptocurrency. Now that I have your attention, I wanted to share more on the subject.

Cryptocurrencies have made international headlines as of late and are the subject of increased media coverage.  This has led many to ponder the nature of cryptocurrencies, ask important questions, and wonder if these new types of electronic money deserve a place in investment portfolios.

The history of cryptocurrency is a relatively short one, as they have emerged only in the past decade.  Unlike traditional cash, no metal coins or paper notes are involved, no central bank issues the currency, and no regulator or nation backs it.  Also, in the case of bitcoin there is a finite supply of 21 million, of which more than 18.5 million are in circulation.  I would like offer answers to some of the frequently asked questions about cryptocurrencies and provide some additional insight. 

What exactly is cryptocurrency? 

Cryptocurrency is, in fact, a form of computer code that is stored in a “digital wallet”, and this digital wallet is only accessible through a password chosen by the user.

What happens if I forget my password?

After a limited number of password attempts, a user can in fact permanently lose access.  Since no central authority exists that is responsible for bitcoin, there is no remedy for forgotten passwords.  German-born programmer Stefan Thomas made headlines after his lost password rendered his bitcoin stash of $220 million inaccessible.  Thomas is one of several bitcoin owners who have been locked out of their wallets- imagine if you were “locked out” of your bank account or investment portfolio!

How can I earn bitcoins?

All transactions are recorded on a public letter called a “blockchain”, and people can earn bitcoins in several different ways.  They can be bought with traditional currencies, and they can also be “mined”.  The mining process involves using highly sophisticated computers to solve extremely complex computational math problems.  Sounds simple, right!

Do cryptocurrencies belong in my portfolio?

To answer this question, we first need to redefine investments such as stocks and bonds.  Companies issue stocks to investors, which offer investors a residual claim on future profits, which can be in the form of capital appreciation or dividend payments.  When companies issue bonds, they offer investors a promised stream of future cash flows (coupons) including repayment of the principal when the bond matures.  These securities provide positive expected returns by allowing investors to share in future profits that are earned by companies.

Digital currencies are essentially cash providing a store of value which can be used towards the purchase of goods and services.  Holding real cash does not provide an expected return of future cash flows and having one Canadian dollar today does not entitle you to more dollars in the future.  The same should apply to digital currencies- we shouldn’t expect a positive return unless we can predict when one currency will appreciate or depreciate relative to others. The ability to predict appreciation or depreciation of currencies has been proven to be extremely difficult, with no reliable way to earn a positive return by simply holding cash.  

Cryptocurrencies are also extremely volatile, which means their price greatly fluctuates.  Most recently, several cryptocurrencies have lost 30-40% of their value in a matter of days, fueling nervousness amongst investors. 

What about regulation?

US regulators have hinted at restrictions, with the Treasury department announcing that any transfer of digital currency valued at $10,000 or more must be reported to the Internal Revenue Service (IRS).  Cryptocurrencies are also still largely unused by most financial institutions, and it is unclear what future regulations may pose. 

How are they taxed?

Gains have been commonly treated as Capital Gains. Most recently, the Australian Taxation Office (ATO) has classified gains from crypto trades similar to gains from other investments.  Under Australian federal law, cryptocurrencies are taxes as a form of property and are subject to the same regulations relating to Capital Gains.  The agency is now sending warning letters to 300,000 taxpayers prompting them to report their gains and losses from cryptocurrency deals when filing their 2021 tax returns.  Taxes will continue to be an issue with governments around the globe looking for their pound of flesh.

What does the future hold?

In the future, cryptocurrencies may have more of a place in mainstream society but until central banks create their own digital currencies, this remains to be seen. There is no reliable way to predict by how much and when appreciation will occur, and holding cryptocurrencies does not entitle holders to an expected future stream of cryptocurrencies.  Caution should be exercised when considering owning cryptocurrencies, and investors should not rush to include them in their portfolios.  Feel free to reach out to your advisor directly if you want to discuss this subject more. 

The views expressed are those of the author and not necessarily those of RGF Integrated Wealth Management, which makes no representations as to their completeness or accuracy.

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