Between the stories we see on the internet, the countless memes, and the growing library of buzzwords, it's hard to research today's economy without running into some references to cryptocurrency. According to the FTC (Federal Trade Commission), cryptocurrency is a type of digital currency that exists electronically.1 You can use crypto like the way you use cash: you can invest in it, use it to buy things, and keep it in your (digital) wallet.
However, as with any investment, there are a few pitfalls to consider before jumping in headlong. Cryptocurrency could be a sound investment for one person and not a good fit for another. To understand whether it's right for you, let's look at five of crypto's pitfalls.
1. Lofty Promises
It's difficult to find an article about cryptocurrency that doesn't contain some hyperbolic claims about the currency's performance. An article from Bloomberg shares some tweets from bitcoin fanatics that say crypto will be the world's biggest benefactor, has saved lives, and may one day hit $100,000 or even $1M a share."2
To an uneducated investor, all of these claims might sound very attractive! Keep in mind that no one can see into the future, and we have no idea how cryptocurrency will perform in the coming years. Approach these claims with a bit of healthy skepticism.
2. Crypto Isn't FDIC-Insured
Another pitfall is that cryptocurrency accounts are not backed by the government like traditional bank accounts. There are third-party companies which offer storage of digital wallets, but if those companies happen to close or go bankrupt, the government has no obligation to step in to help get your money back.
In addition to not being backed by government protection, most cryptocurrency payments don't come with legal protections like credit or debit card purchases do. If you need to dispute a purchase you made using crypto, the process could be long and complicated, if not impossible. In addition, most purchases using crypto aren't reversible. This lack of purchase protection and insurance could be a deal-breaker for some potential investors.
3. Crypto May Be Less Secure
Because your currency is stored online, crypto comes with some inherent security risks, both on- and off-line. For example, there's always the risk of cybersecurity breaches, hacking, fraud/market manipulations, and other technological risks.
Just as important, there are also human error risks that one should consider before purchasing crypto. What would happen if you forgot your password or someone stole your laptop? How would you access your digital wallet? The New York Times famously covered the story of Stefan Thomas, a German-born programmer who had two attempts remaining to guess the password to his digital wallet worth $220 million at the time of writing.3 Cryptocurrency and digital wallets give a new meaning and horror to the prompt "Forgot your password?"
4. Crypto Has Major Environmental Impacts
Even though cryptocurrency is digital, mining for crypto has real-world impacts. Mining requires huge amounts of electricity, and while electricity itself is a relatively clean source of energy, the countries with the highest rates of mining burn fossil fuels to generate electricity. According to the Cambridge Bitcoin Electricity Consumption Index, mining for Bitcoin uses more power globally than entire countries, including the Netherlands, the Czech Republic, and Pakistan.4 And that's just for Bitcoin, which is a single form of crypto. Mining for Ethereum generates more than 62.9 million tons of carbon dioxide emissions, the same amount as Serbia and Montenegro combined.5 According to Digiconomist, a single Bitcoin transaction uses as much power as it takes to run the average US household for over 78 days.6
This environmental impact is a major consideration, especially as more investors are moving in the direction of environmental, social, and governance (ESG) investing.
5. Crypto Still Has to Prove Its Case
Lastly, cryptocurrency is still relatively new and needs more time to prove its case. You can buy more things with crypto now than you could in past years, but you can't buy everything with crypto. In March 2021, Elon Musk said that Tesla would accept Bitcoin as payment but later stated that the company would no longer accept Bitcoin, due to its environmental impact.7 This is just one example of the instability of using crypto as a payment method.
Cryptocurrency is a major player in today's economy, but it's worth taking time to consider its drawbacks before jumping in. A discussion with your fee-only financial planner is a wise first step before making a significant cryptocurrency investment.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.