Bitcoin was in the second half of the past decade one of the most widely discussed investment ideas. This digital currency issued based on unique computer algorithms instead of central banks and governments became a major highlight on a global scope, for the significant increase in its value. Even in the early part of the new decade, it’s not hard to tell that Bitcoin is a force to reckon with.
The increase in the value of Bitcoin cannot be likened to any other asset, more so from a long-term horizon perspective. You will, for instance, find that as the value of investments in Vanguard S&P 500 Index Funds increase by two-digit percentage figures, Bitcoin increase by several hundred or thousand digit percentage figures. Its value has since its inception increased by about 21,000%.
What is Bitcoin?
Unlike the other currencies that we’re used to, Bitcoin does not have a physical form. You store your Bitcoins using a public key.
A public key is essentially a long string of numerals and letters, that are linked through a unique mathematical encryption algorithm. A public key is often thought of as a bank account number that a Bitcoin owner can use to deposit, withdraw or even transfer funds.
The coins are in this case created by miners. Miners are described as independent individuals who usually solve computationally difficult puzzles to discover new blocks that are added to a blockchain, as they receive their reward in the form of a number of bitcoins.
A block is simply the permanent record of all unique Bitcoin transactions, which exists just like a ledger. Every time a block is discovered and created, it paves way for the next block to exist in the blockchain.
This means that a blockchain is essentially a set of permanent records that cannot be changed. The whole bitcoin system is backed by trust in the mathematical operations used to add blocks to the blockchain, not in financial institutions and governments.
The cost of producing Bitcoin is designed to increase with time, and there is a limited number of available Bitcoins, making this currency one whose value is designed to consistently increase as well.
Why the market value of Bitcoin is significantly high
The independence from the traditional financial systems
In most cases, people can transact funds incurring lower fees and within a short time. If you for instance want to make an international purchase through traditional channels such as wire or through bank transfers, you’ll have to wait for a couple of days and incur a given fee. The manufacturer may also take several hours to collect their payment, depending on the nature of their business and the timezone.
With Bitcoin, however, you can complete a transaction through your computer or mobile phone in just a few minutes.
The acceptance of Bitcoin by more merchants
Initially, Bitcoin was mainly used by a limited number of niche companies and few individual early adopters. Currently, a large number of companies have decided to accept payment via Bitcoin. Today, you can pay firms such as Microsoft and Expedia using Bitcoin.
More companies, including the local small scale businesses, are also jumping on this bandwagon, making Bitcoin a more lucrative currency for use in the present-day world.
The unique investment diversification opportunity
Bitcoin offers a good opportunity for the diversification of assets, to investors. This digital currency has so far appeared to operate in the opposite direction of other traditional assets such as equities and fixed income securities.
In addition to that, Bitcoin’s explosive growth has led to the birth of many other cryptocurrencies such as Ripple and Litecoin. The capitalization of the entire Bitcoin market is quite high at the moment and is far above other companies and industries that have been around for long.
The unique potential tax advantages
As is the case with other well-known technologies, government regulations have not been very fast to catch up. Depending on the number of bitcoins that you own and the amount that you exchange, it can get extremely hard for any 3rd party firm to trace back the transactions to you. This essentially means that many Bitcoin owners may have escaped paying taxes for several years. The IRS provided taxation guidelines for Bitcoin in 2014.
Since the IRS currently treats Bitcoin and other digital currencies as property for the purposes of tax, then there are a couple of tax breaks that their owners can benefit from by simply transacting using bitcoin.
Is using Bitcoin for a 401(k) a good idea to implement?
Bitcoin has not received outright support from all investors. They have had differing views about its viability as an asset that can get utilized to help investors grow their wealth. Some of the main arguments that have been put forward in the opposition of Bitcoin as an asset of choice include:
High price volatility
Having covered the upside of owning Bitcoin, we can now talk about the potential risks. Can you stomach a loss of about 20% on the value of your investments in less than two weeks? If you can’t, then Bitcoin may not be the very best option for you to consider. The prices of these digital assets fluctuate quite often, and at a significant margin.
The margin for user error
You should know beforehand that a Bitcoin wallet is essentially a string of unique numbers and letters. If by any chance you lose access to this code, then you will have to forget about your investment for good. You may have heard about the man who discarded a hard drive containing a wallet number of about 1400 bitcoins. Sickening, right? Not forgetting the one who lost $30,000 in Bitcoin after forgetting his PIN. These are just two examples of instances in which the holders of Bitcoin have lost their tokens.
There are also a number of ways in which a Bitcoin transaction can go wrong. If you for instance send your bitcoins to the address of another type of crypto such as Dogecoin, then the bitcoin will most likely get lost. To rectify this error, most of the crypto exchanges in today’s world will require that you meet a transaction minimum (some platforms such as Bittrex have set this minimum as $5000), and will still charge you a considerably high fee to carry through with the recovery.
Bitcoin rules differ from state to state
Some states have implemented legislation aimed at preventing Bitcoin exchanges from serving the citizens living in that state. Bitcoin exchanges such as Kraken and Bitfinex are good examples of exchanges that were forced to give up serving customers ( following the BitLicense regulatory framework). Even Coinbase, another reputable exchange quit its operations in Hawaii after the legislators tightened the legislation.
Such changes in the law can significantly affect an investor’s bitcoin holdings, more so when it comes to liquidation. Issues such as variable costs can also stand in the way of bitcoin holders who do not have very many coins.
I am well aware of the risks, but can I still hold Bitcoin on my retirement account?
As of November 2017, investors had the option to hold Bitcoin on their retirement account in two ways:
Through a 401(k) account
There are three conditions that you have to meet so that you can hold a given amount of bitcoin on an employer-sponsored 401(k). They include:
- Your employer must have selected ERISA 3(21) fiduciary for this plan, and the paid service provider of the plan should be in a position to recommend a fund that offers exposure to Bitcoin.
- Bitcoin-related funds were formally added to the plan’s fund lineup.
- You are in a position to select that fund.
As of now, there’s only one fund that can help you get exposure to bitcoin, namely: Bitcoin Investment Trust. While there are several ETFs, Mutual funds, and hedge funds claiming that they hold bitcoin, the truth of the matter is that they achieve this by purchasing shares from Bitcoin Investment Trust.
Do not forget that the annual expense ratio of Bitcoin Investment Trust is at about 2.0%, while that of the Vanguard S&P 500 index fund is at about 0.14% (these ratios vary from time to time).
You can rely on a self-directed IRA to invest in a large number of financial assets, including cryptos such as Bitcoin. There are, however, a number of costs to consider, including the setup fees, which may range from $600 to $10,000 (depending on the present financial situation. You should also expect to pay some annual fees after that.
You can also use third-party providers that enable you to hold Bitcoin in an IRA. You’ll also have to pay a one-time upfront fee that varies from one bitcoin IRA to the next one. A company such as BitcoinIRA will charge you:
- 15% on all deposits of $15,000 to $100,000
- 13% on all deposits of $100,000 to $200,000
- 11% on all deposits of $200,000+
Conclusion- Exercise caution when using Bitcoin to save for retirement
The one thing I can say about using Bitcoin to invest for retirement is quite possible but is not for everyone. If you have a high aversion to risk, then this asset is one that you may consider staying away from. If your retirement account offers you the chance to diversify using bitcoin, then you should see to it that you limit your allocation according to:
- Your risk tolerance
- The existing state rules that apply to your investment
- Time away from your retirement age.
You can invest anything between 5% to 10% of your entire portfolio, depending on the current amount of money you have.
You should also identify all the applicable costs that are involved in Bitcoin investments, moreso the IRAs. Reach out to your financial adviser as well as your plan provider to verify whether it’s safe or good for you to take up bitcoin investments.
Opening a Bitcoin 401(k) can present its unique benefits and risks, but so will every type of asset that you choose in the present-day world. This means that you have to be willing to bear any risk upon including a certain asset in your portfolio of retirement investments. That said, however, holding Bitcoin for the long term has already worked pretty well for most investors, and most people are still hopeful that it will perform exceedingly well even in the future. You can ask me any questions that you have with regards to this topic- I will offer my best input.
I wish you well,
Eric, Investor and Team Member at Gold Retired!