Investing in crypto is a hot trend right now. There are easy ways to buy Bitcoin — as well as purchase any number of other cryptocurrencies in the news.
However, before you get too involved with investing in crypto, it’s important to take a step back and consider your situation. Just because something seems exciting doesn’t mean it’s a good idea.
Here are some reasons you might think twice before investing in cryptocurrencies.
It’s historically volatile
Cryptocurrency prices are historically volatile, rising and falling quickly. All you have to do is take a look at a price chart for any cryptocurrency. Wide swings from day-to-day are common, even for well-known currencies like Bitcoin.
Other cryptocurrencies also experience wide swings. Ethereum saw a price above $4,000 in May of 2021. But as of July 11, 2021, the price has dropped to just above $2,100. Smaller currencies, like Dogecoin, might see even more dramatic swings.
If you’re looking for something with relatively stable pricing, crypto isn’t there yet.
Valuing cryptocurrencies can be difficult
When valuing stocks, you can look at various characteristics of a company, including its management, balance sheet, and revenues. You can form an opinion as to whether the products and services it offers are likely to succeed in the long run, and you can chart long-term historical value of various stocks and stock indexes.
Other assets, like commodities and real estate, can also be easier to value. Some of these assets are tangible and can be touched.
Crypto, on the other hand, is more difficult to value. You can’t touch cryptocurrencies, and they don’t have a long history like many other asset classes do. Trying to come up with a value that makes sense can be difficult, so comparing it to other asset classes can be tricky.
It’s bad for the environment
The rise in interest around cryptocurrencies has prompted many people to try mining various coins using computer equipment. However, The New Yorker reported that bitcoin is bad for the environment because the process uses a large amount of electricity — and many of the power plants supplying that power are run using fossil fuels.
If you’re interested in making environmentally friendly investments, be aware that some cryptos aren’t as efficient as others. Carefully consider which coins you support with your dollars if you want to avoid those that rely heavily on fossil fuels.
If this is an issue that is very important to you, you might instead want to consider how to invest in renewable energy.
Taxes are really complicated
Filing your taxes is likely complicated enough without figuring out how to pay taxes on your cryptocurrency earnings.
In the end, how you’re taxed depends, in part, on how you received your crypto. If you use fiat currency to buy your coins and then hold them, they are often treated as capital assets, and you have to determine whether you owe short-term or long-term capital gains taxes after you sell.
However, if you receive crypto as payment for services — for example, I got paid 1 Bitcoin in 2011 to write an article — then it’s considered income and could be taxed as ordinary income, based on the coin’s value on the day you received it. This can complicate issues later. If you invest in crypto, make sure you consult a tax professional.
We could be in a bubble on the verge of bursting
With prices rising rapidly over the last several months, there are concerns that crypto could be in a bubble. While there have been ups and downs with cryptocurrencies, the recent runup for many cryptos could indicate this.
When prices get this high, some investors are likely to want to start taking profits. When that happens, they sell their coins for a high price. However, all that selling starts prompting price drops. If the price drops enough, there won’t be buyers for cryptos, and the crash could leave investors who got in later with large losses.
Fiat currencies could work on blockchain
While many enthusiasts point to the blockchain as a public ledger and a secure way to send payments, the reality is there’s nothing stopping fiat currencies from working on the blockchain too. Fiat currencies are currencies issued by a government or its central bank, such as the U.S. dollar.
Some U.S. central bank officials have even suggested the creation of a digital dollar. That means putting the U.S. currency on the blockchain and making it possible to execute transactions using a dollar token. China is currently working on digitizing its currency, and other countries might decide to move forward with similar efforts.
In the end, cryptocurrencies aren’t especially unique in terms of paying for items. Fiat currencies may follow suit.
Cryptocurrencies aren’t truly mainstream yet
Despite the fervor surrounding cryptos, they aren’t truly mainstream yet. You still have to find someone willing to accept the cryptocurrency of choice when you pay or convert your crypto tokens to fiat currency in order to complete a transaction. It’s also important to note that many reports show that a relatively small amount of people control most of the Bitcoin wealth.
Because cryptocurrencies haven't been widely adopted for payment and still aren’t seen as mainstream investments (they’re often pegged as speculation), it’s difficult to say whether they will break through as a viable mainstream asset class down the road.
There’s a potential for fraud and theft
While some cryptocurrencies are legitimate, there is also the potential for fraud and theft. On top of that, because cryptos are so trendy, there are investment schemes surrounding these currencies. It’s bad enough that the Securities and Exchange Commission issued an investor alert about fraud surrounding cryptos. One famous example of a crypto Ponzi scheme was the Bitconnect craze that ended at the beginning of 2018.
Additionally, if someone does manage to get into your crypto wallet, they could steal your coins, and you have no recourse, whether they manage to get into an online wallet or some other wallet.
There’s a lack of regulation
So far, there isn’t much regulation of the crypto market. It’s pretty much the Wild West. There are a number of cryptocurrencies and crypto exchanges, and pretty much anyone can make a coin offering without going through the kind of vetting that a publicly listed company would be subject to.
While the regulatory environment could change, so far, cryptos aren’t protected by SIPC insurance. So if the company managing your crypto holdings fails, you might not have recourse to get your money back.
You don’t have a robust portfolio yet
You might not have a robust investment portfolio yet, so it might not make sense to buy into something like crypto, which is such a new asset class. When creating an asset allocation for your portfolio, you might want to limit your alternative assets to 10% to 20% of the total portfolio value.
Others might be more comfortable allocating a lower percentage to alternatives. For example, I like to keep my alternative investments to about 8% to 10% of my portfolio. That encompasses all of my alternatives, including crypto.
If you haven’t built a solid core portfolio of more traditional assets, it might make sense to bulk up a little bit before adding riskier alternatives like cryptocurrencies.
You’re putting too much of your portfolio into crypto
If you want to add another crypto to your portfolio, take a step back and consider how much of your portfolio is already invested in cryptos. For example, about 5% of my portfolio is in various cryptocurrencies. I am unlikely to invest in another crypto unless I sell something first in order to maintain an asset allocation I’m comfortable with.
When too much of your portfolio is in crypto, you run the risk of losing more than you can afford to if the bubble bursts or price volatility catches up with you.
It’s not supported by the banking system
So far, cryptos still aren’t widely supported by the banking system. That means you have to go outside these regulated channels in order to perform crypto-based transactions. While some exchanges are issuing credit cards that offer crypto rewards or debit cards that allow you access to your coins, the reality is the banking system isn’t there yet.
Some banks do use the underlying blockchain technology for payments, but these payments aren’t necessarily made with popular cryptocurrencies. Instead, the underlying technology is being used to improve their own banking ecosystems.
The market is crowded with made-up currencies
While some cryptocurrencies, like Bitcoin and Ethereum, have made their way into widespread consciousness, there are still plenty of other made-up currencies. In fact, there are more than 5,900 cryptocurrencies as of July 2021.
This makes it hard to tell which currency will catch on. One of the surprising facts about cryptocurrency is that some of them, like Dogecoin, were started as jokes but then saw their price skyrocket before dropping lower. Trying to work out which cryptos will take off and have staying power can be difficult — and you could lose money before it’s over.
What to do if you still want to invest in crypto
There’s nothing wrong with wanting to invest in crypto, if it’s interesting to you. In fact, it could be a way to provide a little extra growth for your portfolio, as long as you have the risk tolerance for it. But before you get started, make sure you only use money that you can afford to lose.
Here are some other tips to help you get started if you want to invest in cryptocurrencies:
Start by learning about cryptocurrencies and how they work. A big thing to know about how to invest money is that it’s important to be careful and understand what you’re getting into. Find out what’s available and learn about the underlying technology. For example, one reason I have Ethereum is its underlying utility in executing smart contracts and its ecosystem for building online apps.
Educate yourself on the risks as well. As with any investment, you could potentially lose money, so understanding the main risks and learning about your own tolerance could help you make better decisions when investing in cryptocurrency.
Check out our cryptocurrency guide for beginners
Our guide to cryptocurrency for beginners can help you learn more about how cryptos work and what you should know before you start investing. It offers step-by-step information about how to buy cryptocurrency, how you can set up a digital wallet, and how to move forward with making decisions that fit your own portfolio goals and strategy.
Sign up for an exchange like Coinbase or Gemini
If you’re interested in owning cryptos and buying them, as well as exchanging your cryptos for others, you can sign up for an exchange like Coinbase, Kraken, or Gemini. With these exchanges, you can easily buy coins with fiat currency and then hold them to see if they’ll grow in value or even exchange them directly for other coins.
You could also get access to other services, such as wallet services or even linked debit cards. To learn more, read our comparison guide: Kraken vs. Coinbase vs. Gemini.
Sign up for an app like Robinhood
If you’re more interested in trading crypto rather than holding onto it, a broader investment app like Robinhood can help. Just be aware that there is no wallet service with Robinhood, and you can’t send your coins to your account, nor can you withdraw coins from your account. You must convert your crypto markers to fiat currency before you can withdraw any profits.
To learn more, read our Robinhood review.
Investing in crypto can be an exciting way to boost your portfolio and make some money. However, before you risk any of your hard-earned money on crypto, do your research and ensure that you have the tolerance for this type of investing.
Disclosure: The author has positions in Bitcoin, Ethereum, and Dogecoin.