What should you know about cryptocurrency IRA's before you open an account? You should be aware that this is a high risk VS. high reward type of an account.
Recently, I was considering an investment into a cryptocurrency IRA. As a cryptocurrency enthusiast, I see the great potential of investing long term in this exciting new sector. Blockchain and cryptocurrency are making huge advancements into real world use cases and I certainly don't want to miss the boat. However, as I did my research there were several important considerations that crossed my mind and that you should consider before investing in a cryptocurrency IRA.
Here are the 10 most important things to know before you make any decisions:
1) Advantages / Disadvantages of Cryptocurrency IRA:
A Few Advantages:
-Possibility of finding the next Apple or Microsoft type of investment
-High long term potential for gains
-Long Term vs Short Term Capital Gains
A Few Disadvantages:
-Unclear Regulations and Tax Laws
-No Government Backing (FDIC or SIPC)
2) Cryptocurrency Landscape: In 2017, blockchain and cryptocurrency exploded onto the scene. It went from a small handful of established cryptocurrencies like Bitcoin and Ethereum into over 1500 new coins or tokens. Each of these represents a project that is attempting to use blockchain or cyrptocurrency in a new way for business purposes. Following the 80/20 rule tells us that 80% of these projects will fail and 20% will succeed. Clearly there is a lot of speculation and potential for huge gains...but also huge losses. Be sure to take time to understand the problem that each project is aiming to solve before you decide to put money into it.
3) Balance Portfolio / Diversification: Another possible advantage of a cryptocurrency IRA is that it offers another layer of diversification in your overall financial portfolio. Most people diversify their portfolios in stocks, bonds, gold etc. Cryptocurrency provides another asset class that is separate from the mainstream markets and are impacted differently. Be aware of your personal overall investment strategy and how a cryptocurrency IRA fits into your overall retirement plan. Remember that cryptocurrency is a new asset class which is still in its infancy, so only invest money that you can afford to lose completely.
4) Emotions: Fear and Euphoria. Both of these emotions heavily impact our mental landscape and cause us to make irrational decisions. It is easy to get caught up in the excitement when the market is exploding, and it is also easy to be crippled with fear when markets are crashing. Don't be so emotionally involved that you miss opportunities, but also make sure you have a well formulated plan to determine the best choices for your investments.
5) No Government Backing: Cryptocurrency is not recognized as a currency in the United States and is not guaranteed through FDIC or SIPC like many other types of financial investments. Many people are comforted knowing that there is some potential recourse for their money if a company or bank fails. By nature, cryptocurrencies usually have no centralized entity and therefore are not insured the same as financial institutions. One advantage of these decentralized assets is that they may not be as susceptible to a systematic financial meltdown like banks were during the great recession in 2008.
6) Regulations: The IRS does not give any guidance on the legitimacy of cryptocurrency in an IRA, but they also do not directly disallow owning them either. As a result, companies that offer cryptocurrency IRA's make the assumption that these investment accounts are legitimate investment vehicles. Just be aware that the topic of cryptocurrency has been heavily debated and each government has a different approach to how they are adopting cryptocurrency. Therefore the regulations governing cryptocurrency IRA's are unclear and could possibly change in the future.
7) Tax Laws Can Change: The purpose of an IRA is to gain tax advantages while you grow your money for retirement. Generally, you can purchase a Roth IRA (Pay the taxes up front) or Traditional IRA (Defer Taxes until later). This is also true of cryptocurrency. However, keep in mind that cryptocurrency is currently recognized as property, not as a currency. This means that owning a cryptocurrency is treated similar to owning a piece of real estate or stocks and are taxed on capital gains. As time goes, on it is entirely possible that cryptocurrency could be classified in the same way that money is for tax purposes. Just keep in mind that the government always wants the best piece of financial pie, and the rules may change as cryptocurrency are more widely adopted.
8) Self Directed VS Custodial IRA: This is all about ownership and who controls the asset (*private keys)
Self directed IRA accounts allow you to make all your own investment choices, and they also allow you to control the *private keys. Generally, a company will charge a fee to help you set up your account and then you are on your own to make investment decisions in your account. Obviously, this requires a high level of education on the IRA owners part but it comes with the trade off of true ownership and less fees.
Custodial IRA accounts are controlled by a company. The company holds the private keys (usually offline in cold storage crypto wallets) and they generally decide which cryptocurrencies are available for you to purchase. Because the company only allows the best, and most well known cryptocurrency, there is less research the investor has to do. In addition, the investor also doesn't need to keep track or fear losing private keys. The downside is there are usually account management fees and trading fees associated with these type of accounts.
Click Here to view my resource page for a recommended Self Directed IRA and/or Custodial IRA company.
9) Company Fees: There are several different companies that have begun offering cryptocurrency IRA accounts, and each company has different fee schedules. Custodial IRA companies have transaction and management fees, while self directed IRA usually just have a flat fee service that is paid to set up your account. Most of these fees are based on the amount of risk the company acquires when they open your account. Remember that volatility in the market and who holds ownership in the account will directly impact the fees you will be charged.
10) Volatility: I know this is an obvious one but it is worth repeating. The cryptocurrency sector is not even a teenager yet! There is a ton of potential for future growth but it has still not completely proven itself in the marketplace. There are still lots of variables influencing the cryptocurrency market and it is still unclear what the true value of each cryptocurrency is. All of this leads to a wildly fluctuating price in your portfolio.
This video may also may be helpful to you:
What I found in my research is that cryptocurrency IRA's offer a high risk vs. high reward scenario. The cryptocurrency market is still so new and volatile that it presents the potential for awesome opportunities, but it also comes with the price of many unknown variables. These accounts are definitely not for everyone and should be viewed with the proper perspective of risk appetite, overall cryptocurrency market awareness, and your individual investment strategy.
I hope this article was helpful for you in making the best decision possible for your future!
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*Private Keys are similar to what a stock certificate is for stocks. Whoever holds the private key associated with a cryptocurrency transaction actually owns the asset.