There seem to be several camps of thought when it comes to investing in cryptocurrencies. The largest camp includes investment firms and investors who add certain “safer” cryptocurrencies to their portfolios after performing a minimal level of due diligence. For them, the choice to buy and hold a cryptocurrency is based on “FOMO”, the fear of missing out and the recognition (and voluntary acceptance) that the risk/reward determination behind the investment is similar to buying lottery tickets. Someone will win, logic goes; it might as well be me.
The other camps, whose sizes are difficult to determine, have done some extensive research and concluded that cryptocurrencies are either:
- A Ponzi scheme dependent on a constant influx of bigger fools,
- A surefire way to get rich if you stick with it, or
- The future of financial exchanges when crypto eventually replaces fiat currency, like the US dollar, which is backed by a centralized federal banking system. They believe that cryptocurrency will provide completely decentralized financial transactions that will free investors from the monetary manipulations of sovereign nations and wealthy oligarchs. They also believe that blockchain crypto technology will revolutionize privacy and security in many uses, from medical records to voting records.
Simply describing the basics of cryptocurrency requires a vocabulary that easily masks its reality. Crypto investment providers have been accused of dismissing valid surveys as petty ignorance on the part of intellectually inferiors. This article will discuss some of the promises and problems with crypto so that you can decide the most important question: is investing in crypto worth your time and money?
Understand the basics
There are three ways to acquire cryptocurrency:
- After opening an account online, you can choose from an overwhelming number of cryptocurrencies to buy through a brokered exchange. Your buying and selling of “coins” will be much like any other security, except the market never closes and the price fluctuation is both highly volatile and completely untrustworthy.
- You can establish a “wallet” to hold the crypto you buy from someone else using one of the many online peer-to-peer access points. This type of ownership carries much greater risks of price manipulation, scammers and a complete lack of privacy (more on that later), but provides the free capitalist environment promised by an unregulated and decentralized exchange. .
- Finally, you can create new coins for yourself by “mining” crypto.
Each unit of a cryptocurrency, the “coin”, is the product of a created “block” (and each coin consists of one million smaller digital units). The block is created when one person, a “miner”, applies a large investment in a series of highly sophisticated, interconnected computers and servers (the hardware alone can cost upwards of $12,000) and the power to calculation (sources report up to 86,000 kWh in electricity expended per piece, costing up to $5,000 in some states) to solve a puzzle which is automatically presented after successfully solving the puzzle that it precedes. Any number of miners attack the puzzle at the same time, and the miner solving it first adds a “block” to the “blockchain” that highlights the coins the winner received for the solution. Blockchain puzzles are solved roughly every 10 minutes, and the difficulty level and coins earned for each new puzzle depend on how many miners attempted the previous one.
The blockchain is a digital ledger that cannot be changed, with each new block being added to the ledger in the order it was created. The blockchain is available for anyone to download and a server with enough memory to hold the entire chain. The correctness of the blockchain is tested via a “proof of work” protocol which verifies the blockchain by comparing the registers stored on these numerous storage servers. If someone attempted to modify the blockchain to fraudulently obtain cryptocurrency, the redundant ledgers would discover the attempt and reject the modification. It is this decentralized system for tracking cryptocurrency ownership that is supposed to provide confidence in its value.
No one can say how many such blockchain ledgers are stored for each cryptocurrency, how often attempts are made to introduce a fraudulent ledger, or how these ledgers are sorted if several different versions are created at once. Given the cost and fragility of hardware, the inevitable occurrence of human error and negligence, and the already well-documented fraud and theft associated with cryptography, any confidence in this decentralized governance as to its accuracy and its valuation can be reckless.
The limits of cryptography
But let’s talk about the crypto market. Despite stories of a few countries and retailers accepting cryptocurrency, which have been debunked or turned out to be trivial, crypto can now only be exchanged for actual fiat currency or other digital assets in the form of “tokens.” non-fungible” or NFT. We are far from having established the market confidence in the value and stability of cryptocurrency necessary for it to be used for the purchase of goods and services, bypassing fiat currency. And that’s the rub: there’s no reason to believe that even the most traded cryptocurrency will ever achieve the price stability needed for sellers to accept it. Today, there is no market for the direct exchange of cryptocurrency, with purchases relying first on the liquidation of crypto into fiat currency.
The Internal Revenue Service (IRS) treats crypto like a financial asset or property and will treat properly documented gains and losses on liquidating crypto like other assets. You may notice that the 2022 Form 1040 includes a question about whether you have ever purchased crypto, even if you have not sold any. Which brings us back to privacy. Crypto transactions are completely transparent to anyone sophisticated enough to examine the blockchain. This digital trail will certainly be used by governments to track trade. It is already undeniable that cryptography is used in money laundering, ransomware attacks, and other criminal activities to evade federal banking oversight. Even though blockchains are secure, other crypto repositories, such as exchanges and wallets, have been hacked, with reported losses of millions of dollars.
The current volatility in crypto prices is absolutely independent of any expectation of its use as a currency. The volatility that crypto owners are experiencing now is the product of rumors and speculation. This is why some believe that cryptocurrency is a Ponzi scheme fueled by stories of sellers profiting from the huge price swings that occur when celebrity investors and billionaires engage in promotions or whenever a new record is set for a digital art crypto purchase. In fact, the only way to make money on crypto is to sell when others are massively buying, because coins have no intrinsic value and are not tied to any production or service.
The Rise of NFTs
Finally, on digital art. Today we see many examples of blockchain technology being used to create non-fungible tokens, or NFTs. An NFT is really a token, a substitute for any digital creation that can be hosted on it. It can be a photo in the form of a JPEG file, a video file, a text file (such as a contract, a deed, a single vote for a political candidate or a poem) or any number of other supposedly unalterable digital files. the creations. The value of the NFT is not in its apparent uniqueness, since it can be easily copied, but in its actual uniqueness, as it is forever tied to its place in the blockchain.
However, an NFT only has the value that one could exchange for it, either in other NFTs or in cryptocurrency coins. For example, if I buy an NFT digital artwork for a Bitcoin today (Bitcoin is trading as I type this at $38,686 per coin), then the seller could sell that coin immediately for dollars or could hold this coin in hopes that it will trade higher later on. For example, Bitcoin was trading at around $67,000 per coin on November 7, 2021, but was also trading at around $29,000 per coin on July 19, 2021. What will it trade next month?
All of this is not to say that cryptocurrency as an investment and method of exchange will or should be phased out. Blockchain technology is an incredible advancement in the security and usefulness of information exchange. Some appropriate uses are already emerging. And investing in more speculative alternative assets is certainly an appropriate part of a diversified portfolio. But we are now in the Wild West of cryptocurrency, and like the western territories of American history in which intrepid settlers blazed the paths of explorers, one must consider the inherent risks faced by early adopters. users.
Senior Vice President, Argent Trust Company
Timothy Barrett is senior vice president and trust attorney at Silver Trust Company. Timothy is a graduate of the Louis D. Brandeis School of Law, 2016 Bingham Fellow, board member of the Metro Louisville Estate Planning Council, and is a member of the bars of Louisville, Kentucky, and Indiana, and of the University of Kentucky Estate Planning Institute Program Planning Committee.