Bitcoin and other cryptocurrencies have been getting a lot of attention lately. Investors hear news about overnight Bitcoin millionaires who lose their fortunes just as quickly. One Bitcoin ranged in price from $1,000 in early 2017 to a high of over $63,000 in April 2021, with intense volatility in between. Understandably, investors have questions—here are answers to some of the most common.
What is Bitcoin?
Bitcoin is a virtual, digital, or “crypto” currency—so called because of the cryptography, or unchangeable coding techniques, involved in the blockchain code on which they exist. The intent of Bitcoin is to allow online payments to be made directly from one party to another through a worldwide payment system, without the need for a central third-party intermediary like a bank. Bitcoin is not issued by any central bank or government and is not legal tender. Like physical gold, Bitcoin’s value stems from a combination of scarcity and the perception that it is a store of value, an anonymous means of payment, or a hedge against inflation.
What's the relationship between Bitcoin and blockchain?
Blockchain, the underlying technology that supports cryptocurrencies, is an open-source, public record-keeping system operating on a decentralized computer network that records transactions between parties in a verifiable and permanent way. Blockchain provides accountability, as the records are intended to be immutable, which presents potential applications for many businesses. While blockchain has often been associated with cryptocurrencies, it has many potential uses beyond payments, including smart contracts, supply chain management, and financial services. Note that ownership of Bitcoins or other cryptocurrencies is not an investment in blockchain, the technology, or its current or future uses.
What is cryptocurrency, and how is it valued?
Fiat currencies like U.S. dollars and euros are forms of money issued by governments to serve as legal tender. Cryptocurrencies such as Bitcoin, on the other hand, are “non-fiat,” non-governmental forms of “digital cash” to be used for electronic payments. The idea of “digital cash” isn’t new; it started with credit cards, PayPal, Venmo and other services’ need for easy, traceable electronic payments. But those payments are tied to fiat currencies managed by central banks, whereas cryptocurrencies are managed by technology, specifically cryptology. Proponents believe the value of a cryptocurrency is based on the quality of the cryptology, the number of cryptocurrency units created, and the technology that limits the creation of additional units. Like any traded item—think baseball cards—the value depends on supply and demand; the fewer units available, the higher the price buyers are willing to pay.
Why has Bitcoin become so popular?
Like many new technologies or products, Bitcoin attracted adherents interested in innovation and the perceived absence of governmental control. Traders saw it as an alternative to traditional investments such as stocks, bonds, and cash, and trading momentum led to a rising, if highly volatile, price. All of this attracted media attention, which drove mainstream awareness and ultimately, increasing acceptance. Most recently, companies including PayPal have announced that they’ll support or accept Bitcoin as a form of payment1.
Who oversees Bitcoin?
Bitcoin was created based on a paper written in 2008 by a “founder” who goes by the pseudonym Satoshi Nakamoto, but no person or agency currently regulates it to ensure that it maintains value and liquidity and works as a means of payment. It’s governed by consensus of a private digital community according to guidelines based on the community, cryptology, and a network of computers. It is promoted by the Bitcoin Foundation, but the foundation does not control or manage Bitcoin’s trading or value. The number of Bitcoins in circulation is limited by and managed by computer code and traded through one of several digital, decentralized exchanges.
Is Bitcoin the only cryptocurrency?
No. Bitcoin was the first cryptocurrency and it is the best known, most widely held, and—with about 60% of the total cryptocurrency market cap2—the most valuable. However, as of March 2021 there were thousands of digital currencies in the marketplace, of which over 700 have a market capitalization exceeding $20 million. Some of the more popular cryptocurrencies include Bitcoin Cash, Cardano, Tether, Ethereum, Litecoin, and XRP.
The Federal Reserve recently announced that it would publish a “discussion paper” this summer on the potential risks and benefits of the central bank issuing a digital currency. Fed Chair Jerome Powell said that the central bank had been exploring the idea for some time, but had made no decision on whether it will move forward with a digital currency. The forthcoming paper will include an opportunity for the public to provide comments on the idea.
Will Bitcoin or other cryptocurrencies become the new global currency?
We don’t think so, but time will tell. To be viable, a currency usually requires three characteristics:
- It can be used as an inexpensive, reliable medium of exchange;
- It can be a unit of account;
- It can be a store of value and legal tender honored as a means of payment.
As long as Bitcoin is subject to high volatility and hefty transaction fees, it likely will have only limited use as a medium of exchange, a unit of account or a store of value. Another barrier to broader public acceptance as a true currency is that, as cryptocurrencies become more widespread, the risk of regulation will probably rise—eliminating part of their appeal.
Should I invest in cryptocurrencies?
Bitcoin and other cryptocurrencies are speculative investments. Bitcoin doesn’t fit within traditional asset allocation models, as it is neither a traditional commodity, such as gold, nor a traditional currency. Bitcoin’s dramatic volatility is driven primarily by supply and demand, not inherent value. Bitcoin doesn’t have earnings or revenues. It doesn’t have a price-to-earnings ratio, price-to-sales ratio, or book value. Traditional value metrics don’t apply, so there are no methods for assessing its value that we endorse or find persuasive beyond the trading value.
Nevertheless, in the 13 years since the underpinnings of Bitcoin were first described3, the cryptocurrency market has developed beyond an initial experimental phase and continued to mature as a new, unique, and sizable asset class. Several institutional investors and corporations have begun to invest in Bitcoin, and some traditional capital-market participants have introduced crypto-market infrastructure services to make it more accessible. Some investors believe that if the lack of correlation with other asset classes continues, cryptocurrencies could add diversification to a portfolio. These showings of validation and confidence may be self-reinforcing, despite significant outstanding uncertainties around legal, regulatory, and compliance considerations.
Whether or not you should invest in cryptocurrencies depends on your goals and preferences as an investor. We suggest that clients approach it as a speculative investment and consider the high volatility and risks involved. For those who already have a diversified portfolio and a long-term investment plan, we see cryptocurrencies as being used primarily for trading purposes outside the traditional portfolio.
Can I get exposure to cryptocurrencies at Schwab?
Yes, you can get indirect exposure. While you cannot purchase or sell Bitcoin or any other cryptocurrency at Schwab (nor do we accept or disburse cryptocurrencies for settlement of securities or futures transactions), Schwab enables several ways to access cryptocurrency markets:
- “Over-the-counter” cryptocurrency coin trusts, such as Grayscale Bitcoin Trusts (GBTC and BCHG), Grayscale Ethereum Trusts (ETHE and ETCG), and Grayscale Litecoin Trust (LTCN) offer exposure to cryptocurrencies, although these can involve high expenses and other risks.
- Clients with a futures account can also trade Bitcoin futures (BTC).
Many aspects of the cryptocurrency market are still immature, in ways that may pose risks for our clients and for Schwab—and US regulators have not yet clarified their approach. We believe that future SEC approval of a cryptocurrency ETF will be a key step in the market’s development, and an attractive, low-cost option for clients interested in this space. But the SEC has been cautious, prudently seeking to validate that this developing market has appropriate safeguards, for example, against market manipulation. When there is more regulatory guidance, you can expect Schwab to have more investment options for clients, including spot crypto trading and custody. And of course if we do bring new solutions to market, like always, you can expect them to be a great value, designed to support client need and surrounded by the advice and education our clients have come to expect from us and deserve.
How are cryptocurrencies taxed?
The IRS treats Bitcoin as property, not currency. Cryptocurrency transactions are taxable by the IRS whenever a taxable event occurs, such as selling Bitcoin for a fiat currency or trading for another asset. Investors are responsible for tracking cost basis, gains, and other reporting. For help, refer to IRS Notice 2014-21, or consult with a tax advisor.
Officials at the Department of the Treasury recently said they will seek to implement stricter reporting requirements on cryptocurrency transactions. The proposal would require that exchanges of $10,000 or more cryptocurrency be reported to the IRS, similar to current reporting requirements for cash transactions. No formal proposal has been submitted yet, so it’s not clear what the timing of such a rule would be. However, it’s important to remember that this $10,000 reporting requirement does not mean that a cryptocurrency transaction of less than $10,000 is not taxable. The tax code states that “all income from whatever source derived” is taxable, even if it’s not reportable to the IRS. For example, an individual who sold $500 worth of items at a flea market would still owe taxes on that income, even though it was not reported to the IRS on a Form 1099.
What are some risks of Bitcoin and cryptocurrencies?
- Financial loss. Bitcoin and other cryptocurrency prices historically have been highly volatile, and fluctuations could result in significant losses.
- Future regulation. Cryptocurrency issuance and trading is currently not well regulated, and additional oversight and regulation in the future is likely. U.S. Treasury Secretary Janet Yellen may be poised to curtail the use of cryptocurrencies. In her confirmation hearing on Jan. 19, Yellen noted her concern over cryptocurrencies being used “for illicit financing.” Both the Trump and Biden administrations have proposed regulations.
- Fraud and cybercrime. These have already occurred. Given concerns above, cryptocurrencies could come under scrutiny from the Financial Crimes Enforcement Network (FinCEN), for noncompliance with the Bank Secrecy Act (BSA) and anti-money laundering requirements. Bitcoin exchanges have also been subject to computer outages caused by excessive demand, and because the ledgers are held on the internet, a large-scale cyberattack could limit access in an emergency—something less likely to happen with cash or gold.
- Theft or loss. A login ID and password is usually required to access a cryptocurrency exchange. If this is lost, hacked, or stolen, access could be denied or lost. While uncommon, Bitcoins can be stored in physical wallets, so they can be spent without a computer; this creates the same risks inherent in all cash currencies: They could be lost, stolen, or destroyed by accident.
Schwab continues to monitor cryptocurrencies as regulations and technology evolve. While some traders may make money on the change in price of Bitcoin or other cryptocurrencies, we suggest that most investors treat them as a speculative asset class primarily for trading with money outside a traditional long-term portfolio.
1See “PayPal to let users pay for purchases at checkout using Bitcoin, other cryptocurrency” published March 30, 2021 by USA Today at www.usatoday.com/story/tech/2021/03/30/paypal-let-you-pay-purchases-using-bitcoin-cryptocurrency/7058545002.
2According to March 22, 2021 data from coinmarketcap.com, indicating Bitcoin market cap of $1.065 trillion, and total global crypto market cap of $1.75 trillion.
3Satoshi Nakamoto published the “Bitcoin: A Peer-to-Peer Electronic Cash System” whitepaper on Oct. 31, 2008.