Should You Invest in Crypto? It's Not a Simple Answer.

Cryptocurrencies: the digital frontier beckoning adventurous investors with promises of untold riches, technological disruption, and financial independence. As the world becomes increasingly digitized, the allure of this new asset class captivates the curious and the risk-takers alike. But as the crypto market surges and skeptics caution against potential pitfalls, a pressing question emerges: Should you dive headfirst into the volatile and enigmatic world of cryptocurrencies, or exercise caution and watch from the sidelines? It's a question that demands careful consideration, so let's explore the pros and cons, the opportunities and risks, and ultimately unravel the mystery of whether investing in crypto is a daring venture worth taking or a speculative gamble better left to the brave few.

When exploring the potential advantages of investing in cryptocurrencies, a world of possibilities unfolds before us. Cryptocurrencies offer enticing prospects such as high returns, diversification of investment portfolios, and the perception of being a hedge against inflation. As we delve into this section, we will examine these advantages in greater detail, shedding light on the potential benefits that have attracted investors to the captivating realm of digital assets.

Cryptocurrencies can provide diversification for an investment portfolio. Historically they have had a relatively low correlation with traditional asset classes like stocks and bonds. Adding cryptocurrencies to a portfolio can potentially reduce overall risk by spreading it across different types of assets.

• Low Correlation: Cryptocurrencies, such as Bitcoin and Ethereum, have historically shown a low correlation with traditional asset classes like stocks and bonds. This means that their price movements often occur independently of traditional markets. By adding cryptocurrencies to a portfolio, investors can potentially reduce the overall correlation and diversify their holdings, which can help mitigate risks associated with market downturns in specific asset classes.
• Nontraditional Asset Class: Cryptocurrencies represent a nontraditional asset class with unique characteristics. Unlike stocks or bonds, cryptocurrencies are digital assets based on blockchain technology. Their value is determined by factors such as market demand, technological advancements, adoption rates, and network usage. Adding cryptocurrencies to a portfolio can introduce exposure to this innovative and evolving asset class, which can provide diversification benefits by tapping into different market dynamics.
• Different Market Cycles: Cryptocurrencies have their own market cycles that can differ from traditional financial markets. They can experience periods of rapid growth, known as bull runs, followed by significant corrections. These cycles can be driven by factors specific to the cryptocurrency market, such as technological advancements, regulatory developments, and investor sentiment. By including cryptocurrencies in a portfolio, investors can potentially benefit from these unique market dynamics and capture returns that are distinct from traditional asset classes.
• Global Market Exposure: Cryptocurrencies operate in a global market that is not limited by geographic boundaries. The decentralized nature of cryptocurrencies allows for participation and investment opportunities from around the world. By investing in cryptocurrencies, investors gain exposure to a global market that can be influenced by different economic, political, and technological factors, providing further diversification to their portfolio.

Cryptocurrencies have gained a reputation for being one of the highest-performing asset classes in recent years, showcasing remarkable growth and delivering substantial returns for investors over their relatively short history. When compared to traditional asset classes, cryptocurrencies have often outperformed stocks, bonds, and other investment options. In some instances, the returns on cryptocurrencies have far exceeded those of traditional investments, attracting the attention of investors seeking high-growth opportunities. Bitcoin, for instance, surged from mere fractions of a cent in 2009 to reach an all-time high of approximately $69,000 in 2021. Other cryptocurrencies like Ethereum, Ripple, and Litecoin have also witnessed significant price increases, leading to substantial returns for early investors.

Before you can fully understand how crypto can be a potential hedge against inflation, it's important to understand inflation and how it works. Therefore, it's recommended to read the previous Escient Financial Insights article Understanding Inflation: What Investors Need to Know and the Inflation vs. Deflation section of the previous Escient Financial Insights article Bitcoin – The Who, What, When, Why, and How.

Simply, part of the reason inflation occurs is continuous printing of new money. There are other aspects to and causes of inflation, such as interest rates, consumer goods supply and demand, employee wages, and more, but generally if the central bank is printing new and more currency, then that currency is losing value.

On the other hand, while inflation erodes the purchasing power of traditional currencies, some cryptocurrencies, such as Bitcoin, are designed to have a finite supply. Some cryptocurrencies may already have their maximum currency supply in circulation, while others like Bitcoin are slowly inflating at a rate that decreases over time until the maximum supply is reached. There are even some cryptocurrencies that are actually deflating, meaning the supply of the currency that's in circulation is actually decreasing.

Cryptocurrencies operate on decentralized networks, typically based on blockchain technology. They are not controlled by any central authority or government. This independence from traditional financial systems and centralized control can make cryptocurrencies less susceptible to the monetary policies of governments and central banks. In times of inflation or economic uncertainty, some investors may see cryptocurrencies as an alternative store of value that is less affected by traditional economic forces.

Cryptocurrencies offer global accessibility and can be traded 24/7 across different jurisdictions. This accessibility allows investors to diversify their holdings beyond traditional currencies, potentially providing a hedge against inflation in specific regions or currencies. Investors can also use cryptocurrencies as a medium of exchange or a store of value in countries experiencing hyperinflation or economic instability.

As discussed in the previous Escient Financial Insights article Is Crypto a Scam?, crypto as a whole is not a scam. It's important to keep in mind that there are many crypto projects and tokens that definitely are scams, and there are people who will attempt to use crypto for their scams. This is not something unique to crypto though, as there are many cases of scams and fraud in traditional finance and traditional stock markets. Crypto may make it easier for individuals to concoct and run their scams, though, so extra care is needed when investing in crypto. If you do invest in crypto, it's important to be careful and make sure you do your own research, or enlist a trusted advisor, to help you determine which crypto projects, tokens, and coins to purchase and invest in.

When it comes to custody of crypto, there can be more complexity, which makes using crypto more confusing, and even more risky.

Cryptocurrencies are digital assets that exist solely in electronic form. Unlike traditional assets like physical cash or stocks held in brokerage accounts, cryptocurrencies are intangible and require specialized digital storage solutions. This digital nature can make custody processes less familiar and more complex for individuals who are accustomed to traditional financial systems.

Cryptocurrencies are secured using cryptographic keys, specifically public and private keys. The private key is crucial for accessing and managing cryptocurrency holdings. Self-custody involves securely storing and managing these private keys to protect against unauthorized access, theft, or loss. Managing private keys effectively requires a good understanding of blockchain protocols, wallet software, and transaction processes to securely store and handle cryptocurrencies. Additionally, staying updated with advancements, network upgrades, and evolving industry standards can be challenging.

Due to the complexities and risks involved in self-custody, individuals and institutions often turn to specialized custodial services provided by reputable companies. These custodians offer enhanced security measures, insurance coverage, regulatory compliance, and expertise in handling digital assets. However, selecting the right custodial solution requires careful consideration, due diligence, and understanding of the specific needs and risk tolerance of the investors involved.

The regulatory landscape surrounding cryptocurrencies is still evolving and varies significantly from one jurisdiction to another. This lack of uniformity and clarity can create uncertainty for businesses and individuals operating in the crypto space. Regulatory frameworks can be complex, subject to change, and often require interpretation, making it challenging for market participants to navigate and comply with the rules.

Governments and regulatory bodies have expressed concerns about certain aspects of cryptocurrencies, such as their potential use in illicit activities, market manipulation, and investor protection. As a response, regulatory measures may be introduced to impose restrictions or limitations on crypto-related activities. This can include stricter KYC procedures, limits on trading or investment amounts, bans on certain types of transactions or tokens, or licensing requirements. Such restrictions could hamper the growth and innovation of the crypto industry and limit the opportunities available to investors and businesses.

Regulatory actions and announcements can significantly impact the sentiment and stability of the crypto market. Regulatory crackdowns or unfavorable regulations in major jurisdictions can cause market volatility, leading to price fluctuations and increased investor uncertainty. Uncertain or restrictive regulations may also discourage institutional participation, as they often require more regulatory clarity and certainty to navigate compliance and risk management obligations.

It is important to note that while regulatory challenges exist, they also aim to protect investors, mitigate risks, and foster market integrity. The maturation of regulatory frameworks can bring legitimacy and institutional confidence to the crypto industry, potentially attracting more mainstream adoption and investment. However, striking a balance between regulation and innovation remains a complex challenge that needs to be carefully addressed to ensure the sustainable growth and development of cryptocurrencies.

Tax regulations regarding cryptocurrencies can be complex and often lack clarity. Tax authorities may struggle to keep up with the fast-paced nature of the crypto market and the evolving technology behind it. Determining how cryptocurrencies should be classified, valued, and taxed can be challenging, leading to confusion and potential errors in compliance.

Crypto taxation requires individuals and businesses to maintain detailed records of transactions, including the acquisition, disposal, and value of cryptocurrencies. The need to track every transaction and calculate gains or losses can be burdensome, particularly for active traders or businesses that accept cryptocurrencies as payment. The complexity of reporting requirements and the need for accurate record-keeping can result in increased administrative work and potential compliance errors.

The increase in the value of cryptocurrencies can lead to significant tax liabilities when crypto assets are sold or exchanged for traditional currencies or goods and services. Taxation based on capital gains or income from crypto-related activities can result in substantial tax obligations, particularly for those who have accumulated significant gains or engage in frequent trading. Paying taxes on crypto gains can reduce the overall profitability of investments or limit the potential for reinvestment.

Calculating the tax liability for cryptocurrencies can be technically challenging. Factors such as the determination of the cost basis, accounting for different types of transactions (e.g., exchanges, forks, airdrops), and handling wallet transfers can add complexity to the tax calculation process. Although more tools and tax software tailored for cryptocurrencies exist and more are coming out, they do have an added cost, and could be quite expensive for those with hundreds and even thousands of transactions, further complicating the process for individuals or businesses.

Tax authorities may struggle to provide timely and comprehensive guidance on cryptocurrency taxation due to the novelty of the asset class. This lack of guidance can leave taxpayers uncertain about how to accurately report their crypto-related activities. As regulations evolve and tax authorities issue new guidelines, taxpayers may face challenges in staying up to date and ensuring compliance.

Taxpayers should consult with tax professionals or accountants who specialize in cryptocurrency taxation to ensure compliance with the applicable laws and make informed decisions.

Estate planning involving cryptocurrencies can present unique challenges and complexities. Here are some difficulties associated with estate planning for crypto assets:

• Digital Asset Management: Cryptocurrencies are digital assets that exist solely in electronic form. Unlike traditional assets like physical property or bank accounts, cryptocurrencies are intangible and stored in digital wallets secured by cryptographic keys. Managing and accessing these assets after the owner's death requires a clear understanding of the private key management process and knowledge of the deceased person's wallets and holdings.
• Complexity of Private Key Management: Private keys are essential for accessing and transferring cryptocurrencies. If the private keys are lost, forgotten, or not properly documented, it can result in the permanent loss of the crypto assets. Estate planners and heirs need to identify and locate the private keys or employ suitable methods for secure key management to ensure the smooth transfer of crypto assets to beneficiaries. This is complicated by the need to keep private keys secure in a manner so that those who should not have them cannot have them.
• Lack of Centralized Authority: Cryptocurrencies operate on decentralized networks, and there is no centralized authority or institution that can facilitate asset transfers or provide account recovery services. In the event of the owner's death, there is no default mechanism to transfer or recover the assets. Without proper planning and documentation, heirs may face significant challenges in accessing and managing the crypto assets.
• No Uniform Standard for Beneficiaries: For those who keep their crypto assets on a centralized exchange, not every centralized exchange has a specific way to declare an individual as a beneficiary to an account should the account owner pass. That makes it difficult to get proper legal access to a deceased's crypto assets.
• Privacy and Confidentiality Concerns: Cryptocurrencies offer a level of pseudonymity and privacy, which can make it difficult for heirs or estate administrators to identify and locate the crypto assets held by the deceased. The nature of blockchain technology allows individuals to transact without disclosing personal information. As a result, without proper disclosure or documentation, the existence and extent of crypto holdings may remain unknown, making it challenging for estate planners to account for these assets.
• Legal and Regulatory Uncertainty: The legal and regulatory framework surrounding cryptocurrencies is still evolving, and there may be variations in how different jurisdictions treat crypto assets in estate planning. The lack of uniformity and clarity in regulations can create uncertainties and legal complexities when it comes to transferring and distributing crypto assets as part of an estate.
• Valuation Challenges: Cryptocurrencies are known for their price volatility, and determining the accurate value of crypto assets at the time of the owner's death can be challenging. Estate planners may need to engage professionals with expertise in crypto asset valuation to ensure accurate assessment and fair distribution among heirs.

Given these difficulties, individuals who hold cryptocurrencies should consider the following estate planning measures:

• Documenting crypto holdings, wallets, and private key information.
• Establishing clear instructions and guidelines for heirs regarding the management and transfer of crypto assets.
• Engaging legal and financial professionals experienced in crypto estate planning to navigate the complexities.
• Regularly reviewing and updating estate plans to account for changes in crypto holdings and technologies.
• Communicating with heirs about the existence and nature of crypto assets to ensure a smoother transition.

Proper planning and professional guidance can help mitigate the challenges associated with estate planning for cryptocurrencies and ensure that the wishes of the deceased regarding their crypto assets are carried out effectively.