Cryptocurrency inspires strong opinions among investors, from believers that it’s a transformative technology to those who worry it’s just a passing fad. Regardless of your perspective, it’s important to separate fact from fiction as you evaluate this new asset class.
Crypto is an electronic, decentralized, digital form of money that uses concepts from cryptography (the science of keeping data secure), computer science (the discipline that allows computers to process information consistently) and economics (the principles that encourage people to follow rules for the good of everyone). Cryptocurrency is a volatile investment. High-risk investments should make up a small percentage of your total portfolio — one commonly accepted guideline is no more than 10%.
The first crypto, Bitcoin, was created to allow people to send value electronically from one person to another without a middleman. It accomplished this by creating a global network, or blockchain, that verifies transactions securely. The Bitcoin network is open source, so anyone can see how it works and contribute to its improvement. The success of the Bitcoin network has fueled development of other cryptocurrencies, such as Ethereum, which is used to support a wide range of applications, including insurance and real estate titling.
Like any other financial assets, cryptocurrencies are subject to taxes. The IRS treats them as securities, and the amount you pay depends on how long you hold them and what you do with them. If you sell them for a profit, the profits are taxed as capital gains. If you trade them, the profit is taxed as ordinary income.
Most cryptocurrency trading takes place on exchanges, which are platforms where you can buy and sell coins. You can find a lot of information on exchanges online, including their reputation and reviews from other users. As with any type of investing, it’s a good idea to research exchanges thoroughly before making a deposit.
You’ll need a wallet to store your crypto assets, which is how you retain the private keys that unlock your digital currency. There are many types of wallets, from software to hardware devices designed for safe storage. Some wallets are geared toward maximum security while others prioritize convenience. In either case, it’s a good idea to use a wallet that is backed by a reputable organization.
Despite their volatility, cryptocurrencies can be a smart addition to your investment portfolio. They can help you diversify your holdings, potentially increase your yield and reduce the risk of exposure to a single market.