An IRS notice in 2014 declared that cryptocurrencies are “property,’ rather than currency, for tax purposes. The decision opened the door for cryptocurrency investments in traditional and Roth IRAs. All IRAs need an IRS-approved custodian to maintain the IRA’s tax-free (Roth) or tax-deferred (traditional) status. Contrary to popular opinion, a specific Bitcoin or Cryptocurrency IRA does not exist. Investors who seek to place cryptocurrencies in an IRA utilize custodians that support self-directed IRAs (SDIRA).
The maximum amount of funds that everyone can invest and deduct for personal income tax purposes each year is currently limited to $6,000 (plus another $1,000 for those over age 50). However, there is no limit to the number of IRA accounts a person might have. For example, an individual might contribute to a traditional IRA and a SDIRA, a traditional IRA and a Roth IRA, or two SIDRAs.
Investors who acquire cryptocurrency in a traditional IRA can deduct their investment from ordinary income in the year of purchase but must pay regular taxes on the income withdrawn at retirement (tax-deferred). Those who establish a Roth IRA do not get an income tax deduction but have no tax liability for withdrawals after the age of retirement.
Based on their past price performance over the years, cryptocurrencies are ideally suited for Roth IRAs. For example, imagine you invested $1,000 in BTC in a Roth IRA on January 2nd, 2016, at least five years after BTC was publicly available. With Bitcoin trading at $435.40 that day, you would have received 2.296 BTC. As of May 18th, 2021, your Bitcoin Roth IRA would be worth $98,702.19. That’s an incredible increase of over 98 times your money. While no one knows what future prices for BTC might be. i.e., what happened in the past may never occur again; those who invested and held BTC for similar periods were undoubtedly very pleased with their results.
Slightly over a decade ago (2009), the first viable digital currency – Bitcoin – appeared, the forerunner of today’s cryptocurrencies. The new “money” quickly became popular with computer aficionados, first adopters, and those needing an anonymous, untraceable exchange vehicle and system to transact illegal or unsavory activities. The developers of Bitcoin and later cryptocurrencies envision a future where digital money replaces fiat money – currency issued and controlled by a government.
Money, as we know it today, has evolved significantly since its early use in barter transactions. Nonetheless, its present state in the form of fiat currencies presents significant problems in a modern, connected world:
A money system based on cryptocurrencies offers many advantages over the existing fiat currencies. The issuance of a cryptocurrency is decentralized, unlike the dollar controlled by the U.S. government. Instead, it is the payment network that is in control. Policies are hard coded in and invulnerable to manipulation.
Bitcoin and subsequent versions of digital money rely on blockchain technology – “an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way,” a definition attributed to a February 2017 Harvard Business Review. Thie technology means that no one person, institution, or government has central control. Cryptocurrency’s decentralized, open-source nature helps “eliminate the weak points of the modern banking system by bringing access directly to consumers,” according to Claire Lovell, Associate Director of Product Management at Gemini. This feature makes it easier to buy, sell, store, and trade the last decade’s best-performing assets.
David Tawil, a co-founder of the hedge fund Maglan Capital, claims, “It [digital currency] is the natural and logical next step in financial services in the world. Once upon a time, shares of stock were physical and transferred physically; those shares are now entirely digital. Similarly, currency needs to be digital and global.”
While many expect that a cryptocurrency like Bitcoin (BTC) or Etherum (ETH) will eventually replace fiat money as a transaction medium, that likelihood depends on their shrinking volatility. For example, merchants are unlikely to accept Bitcoin as payment when its value can vary up or down 20% in a short time. For the same reason, buyers are reluctant to pay bills with Bitcoin. The story of Laszlo Hanyecz’s purchase of two pizzas for 10,000 BTC in 2010 serves as a warning to those tempted to discount future price increases for the cryptocurrency. If Mr. Hanyecz had eaten a hamburger that day, he would be $400 million richer. Ethereum, the second most popular cryptocurrency, increasing from $0.6923 on August 11, 2015, to $1598.26 on March 25, 2021, a compound growth rate of more than 300% each year.
Perhaps you are one of those who have watched the development of cryptocurrencies over the past decade. Maybe you considered digital money a “fad” or another investment scam that periodically grabs investor attention before fading into oblivion. You have been tempted to invest, even kicking yourself for passing up the opportunity to buy BTC when it was selling at $300 five years ago. Still, you are afraid to take the final step of investing in a cryptocurrency. As you think about your next step, consider the following reasons that many people are purchasing digital money for the first time:
While the price performance for cryptocurrencies has been spectacular in many cases, its potential as a market disruptor has barely become. The United States’ total M2 money supply – cash, checking deposits, savings deposits, and money market securities – at the end of February 2021 was almost $20 trillion. The year-over-year percent change in the M2 supply in 2020 is now north of 23%. To put that in perspective, year-over-year growth in the M2 money supply had never exceeded 15% until 2020, according to Fed records dating back to 1981. Morgan Stanley chief U.S. equity strategist Mike Wilson notes, “The risk of higher inflation may be greater than it’s ever been, too. While this hasn’t shown up in back-end rates yet, the very sharp move higher in break evens [bond market inflation expectations] and precious metals suggest higher inflation may be on its way.” A return to higher inflation will likely spur investors to invest in cryptocurrency to escape the inevitable loss in value due to inflation.
The market cap of Bitcoin in March 2021 was slightly below $1.2 trillion. The total number of BTC that can be issued – a hard cap – is 21 million. If BTC replaced just 10% of the U.S. M2 supply, the theoretical price per BTC would potentially rise to $95,238. Suppose investors decide to diversify their S&P 500 investments – approximately $32 trillion in March 2021 – into BTC by 10%. In that case, the theoretical price will rise to $152,380 per coin. While these scenarios are speculative, the possibilities illustrate the upside potential of the most popular cryptocurrency.
In its short history, cryptocurrency has proven to be an excellent store of value. Cryptocurrency can be purchased, saved, retrieved, and exchanged in the future, much like gold and silver, traditional stores of value for hundreds, if not thousands of years. Unlike physical commodities that are difficult to transport and require extensive physical security, cryptocurrency is digital, easy to use as a checking account, and safe with the proper digital safeguards. The blockchain ledger’s different mathematical puzzles are hard to decode, making a cryptocurrency more secure than ordinary electronic transactions. According to Nasdaq, no transaction mechanism is currently more safe and secure than those that use cryptocurrency.
Over the last ten years, BTC has proved to be a superior Investment to popular alternatives like gold and silver, especially for those who buy and hold the cryptocurrency. Those who purchased the digital money in 2018 at its high ($17,436) and watched the price fall to $3,392 by the end of the same year were well rewarded two years later when it traded above $60,000 per coin.
While Bitcoin has easily outperformed the two precious metals, its price is extremely volatile over the short-term. Potential investors need a high risk-tolerance and should take appropriate risk-management measures when investing. The Betterment financial advisory firm offers tips to invest in cryptocurrency responsibly.
Other factors indicating cryptocurrency’s future growth include:
A March client survey by Goldman Sachs showed that 40% of respondents held cryptocurrency, and nearly two-thirds of them expected to invest more in the next two years.
In the initial years of digital money, governments did not know how to treat the new currency. Some ignored it, while others tried to suppress it. For example, China banned cryptocurrency exchanges in 2017, driving the business underground and creating a vast gray market. Most governments recognize the inevitability of cryptocurrency’s growth, especially where citizens lack confidence in the fiat currency, and opt to regulate it.
Their actions and intended regulations eliminate the market’s abusive elements and clarify legal and tax issues that previously existed to create a more viable, transparent market. According to the Balance personal finance website, “Overall, this [regulation] is a good thing for people who want to invest in cryptocurrency. Safer markets mean more public confidences, which often means prices go up over time.”
Specifically, some of the biggest and most innovative companies in the world are buying crypto in bulk. The Motley Fool website noted that MicroStrategy, Square, and Tesla owned billions of dollars in BTC. MassMutual, the giant insurance company, purchased $100 million of Bitcoin in late 2020. The leading cryptocurrency exchange, Coinbase, is about to go public at a valuation of around $100 billion. In the last quater of 2017, CME Group started offering futures markets for Bitcoin transactions, so now cryptocurriencies trade on the worlds largest echange offering derivativies.
Initial coin offerings (ICO) – cryptocurrency version of an Initial Public Offer (IPO) – are an alternate, more flexible, and less expensive way for startup, small and medium-sized companies to raise capital than the traditional IPO. An initial coin offering is a fundraising tool similar to a crowdfunding campaign, but the offering is a form of digital money. There are no restrictions on the sale or transfer of crypto coins (unlike an IPO), thereby offering greater liquidity to investors than traditional equity investments.
What does the future hold for cryptocurrencies IRAs? John Collins, a former professional staffer for the U.S. Senate Committee on Homeland Security and Governmental Affairs, helped lead the first Congressional hearing on cryptocurrency in 2013. He feels that the asset’s most significant hurdle to future growth is institutional investors’ acceptance, like hedge funds with more dollars in play. He also noted the decision by BNY Mellon to accept cryptocurrency in a customer account, “”There’s probably no older old-school, white-shoe bank than BNY Mellon, and for them to make that decision even a few years ago would have been totally unexpected. A lot of banks were totally shying away from even banking cryptocurrency companies, let alone holding cryptocurrency on their books themselves.”
Many believe the future will see a transition to decentralized finance, i.e., banking is done without the need for banks. James Lee, a certified financial planner and an advocate for cryptocurrencies, advises that virtual currencies under development will one day become more consequential than BTC. Others agree that society is just beginning to scratch the surface of digital coins.