Is it an alternative currency? A technology? A venture capital investment? A specious bubble?. Cryptocurrency is decentralized digital money, which works based on blockchain technology.
In the past six months, cryptocurrencies have seen their prices skyrocket on the back of tweets, comments on social media, and advice from random people, some of who barely know anything about how cryptocurrencies work. There are now over 4,000 Cryptocurrencies in circulation in 2021 vs. 180 sovereign currencies recognized as legal tender in United Nations (UN) member states.
When a financial advisor discusses the appropriate asset allocation for a portfolio, they are essentially trying to construct a plan that maximizes expected returns based on a given level of risk.
The advisor pays less attention to the behavior of individual security and instead focuses on how different asset classes work together as a group.
So, what is bitcoin’s role in an investment portfolio, and does it make sense to incorporate it?
How risky Cryptocurrency can be for you.
About two months ago, Noida-based Gaurav Tyagi considered Elon Musk a visionary who would lead the world into a tech-enabled and financially secure future. But not anymore. After Musk announced that his company would stop accepting bitcoins to purchase Tesla cars and expressed concern over the environmental impact of bitcoin mining, the crypto market came crashing down in mid-May.
It was a midsummer nightmare for investors like Tyagi. Within a week starting 13 May, the value of his crypto holdings crashed by more than 60%, from around Rs 55,000 to less than Rs 20,000, as panicky investors rushed to sell their coins. “Elon Musk acted irresponsibly without concern for the millions of investors who such decisions would impact,” he says glumly.
Tesla’s U-turn on cryptos was not the only trigger. Around the same time, the Chinese government had cracked down on institutions dealing with cryptocurrencies. These two developments triggered panic selling in cryptos. “Apart from panic selling, many investors chose to book profits at this stage, which led to a steeper fall in crypto prices,” points out Nischal Shetty, CEO, and founder of WazirX, a crypto exchange set up in 2018.
Crypto prices have zoomed in the past 12 months, churning out mind-boggling returns for investors. Even after the recent decline, the price of a bitcoin is nearly 400% of what it was a year back. In addition, some smaller coins like the Dogecoin are trading at 140 times its June 2020 level while Matic Network has risen by over 7000%.
Cryptocurrency is on fire for all the investors.
Still, everyday investors are crypto-curious. Some of the most visible financial influencers are also starting to talk and think about crypto more. Tori Dunlap of Her First $100K recently told us that she still errs on the side of caution and tells people to follow the 5% rule – that is, don’t contribute more than 5% of your portfolio too risky assets like crypto.
“I think it is imperative to consider that these things are still speculative,” says Dunlap, who saved her first $100,000 by age 25 and is on track to have $6 million saved by the time she retires. “If you are investing a certain amount of money, you should maybe be OK losing that amount of money.”
As with any new investment, it’s essential to do your research and understand all risks. Experts say you shouldn’t invest in crypto if it means you can’t meet other financial needs, like paying off debt, building an emergency fund, or maxing out other retirement accounts. And just because crypto is new and exciting doesn’t mean you need to invest in it at all — people have been successfully saving and investing for retirement since long before crypto was around.
More than 60 percent of young students in the US see crypto as a long-term investment. Some 24 percent have an appetite for “moderately aggressive” risk, according to a survey of more than 500 college students and grads published by College Finance. This site specializes in advising student loan borrowers.
Read Is it too late to purchase bitcoin?
Bitcoin’s price is up nearly 16 percent so far in 2021 after being up 122 percent at one point. The adoption by institutional players to crypto assets from the last quarter of 2020 accelerated the move in their prices. By comparison, gold, bitcoin’s closest traditional rival asset, is down 1 percent in 2021.
The recent rise of Bitcoin toward all-time highs is creating millionaires, on paper, at a relatively rapid clip, according to data from BitInfoCharts. There are 78,870 accounts holding bitcoins worth at least $1 million, and there are 6,797 that own bitcoins valued at more than $10 million, according to BitInfoCharts.
Crypto-exchange Coinbase said its more than 56 million users accounted for $335 billion in trading volume in the first quarter: $120 billion retail and $215 billion institutional. That compares to $30 billion in total a year earlier, of which $12 billion was retail.
Read Elon Musk is creating his own new crypto.
The Bottom Line
The RBI, in 2018, banned all banks from dealing in cryptocurrencies, but a Supreme Court order overturned this ban on a plea by the Internet and Mobile Association of India (IMAI). The court said that while the RBI has the power to regulate virtual currencies, in the absence of any legislation, the business of dealing in these currencies ought to be treated as a legitimate trade that is protected by the fundamental right to carry on any occupation, trade or business under Article 19(1)(g) of the Constitution.
While the RBI is not comfortable with the idea of cryptocurrency as a medium of exchange, the government’s stance on this issue is not clear. The government has proposed a bill to regulate cryptocurrencies called The Cryptocurrency and Regulation of Official digital currency Bill, 2021. The Bill has provisions to make any dealings in cryptocurrency illegal. But there is no clarity yet on when this Bill will be introduced in Parliament. As a result, banks are staying away from crypto transactions since the RBI hasn’t clarified its position officially.
In the past, unregulated investments and financial institutions have resulted in significant crises. One example is the unregulated Chit funds market which used to thrive in India. In the absence of regulations, there have been many cases of fly-by-night operators, resulting in massive losses to customers. In addition, there have been other examples, such as microfinance and gold loans, where lack of regulation has led to crises.
Since income from whatever source derived is included in the Income Tax Act, 1961, and supply of any service, if not specifically exempted, is taxable under Goods and Services Tax (GST), the gains from cryptocurrency (crypto) trading and services by crypto exchanges are liable to be taxable.
Crypto assets offer one more asset class, especially for young traders/investors who want to get rich quickly and know the risks involved. In a sense, it is similar to trading in penny stocks. However, once the regulations evolve and the volatility reduces, even risk-averse investors can consider investing a proportion of their wealth in these assets.