As the use of Bitcoin expands as a medium of exchange there are questions emerging about its fluctuating price and whether it has value as a stand-alone investment. Some price swings can be extreme due to its new and unknown role in global finance. Under IRS guidelines, Bitcoin is treated as an asset rather than a currency, putting it in a class along with commodities and stocks. Whether speculative traders or long-term investors, those seeking to capitalize on the Bitcoin market should consider the following:
Speculation and Investment Issues: Because it was originally created to act as an alternative digital payment method, Bitcoin does not have the same kind of investment qualities as other assets. Unlike currencies, there is no governmental backing no matter how slight that may appear at times. There are few opportunities to profit from use of investment leverage on price change, such as options or futures. Speculators who have success timing news events and government action can profit from simply holding Bitcoins, but that price action can cut both ways bringing losses. There may be more speculative trading opportunities that are offered in the future as interest increases in this type of emerging asset, which attracts those seeking price volatility.
Capital Gains Treatment: Because the IRS defined digital currency as an asset, it will carry a capital gains tax if the price changes from the time of purchase to a subsequent sale. This differs significantly from the way that currencies are viewed and treated for tax purposes. Tracking and reporting this can be problematic if one uses Bitcoins frequently. For now its unlikely the IRS has the capability to monitor multiple anonymous transactions in Bitcoin, but investors are well advised to be transparent and complete in their reporting to the IRS. Anyone planning to invest in Bitcoin for any time period has to take into account this tax burden and reporting challenge.
Finite Supply of Bitcoins: The fact that there are eventually a finite number of Bitcoins that can be mined creates a cap on supply, and that should mean the value would increase as the supply becomes limited. It is hard to predict exactly how that would affect the price, or what other factors might come into play before that occurs. However, it does provide some incentive for one to hold some Bitcoins as a small part of an investment portfolio, similar to the way one could hold gold coins or bullion.
Governmental Policy and Regulation: The most compelling risk to Bitcoin value is that of governmental regulation that could affect the way that it is used and accepted. Any time that a country places restrictions on the role of Bitcoin, the price can change dramatically. Given the recent trend toward defining Bitcoin as an asset without currency status it seems that governments are committed to eliminating any competition to their own fiat currencies. However, these actions pale in comparison to proposed rules that would reduce the anonymous nature of Bitcoin transactions, and create third party supervision of exchanges and others doing business in Bitcoin.
One of the common assertions by policy makers is that Bitcoin is not backed by any government or commodity, and therefore poses risks that currencies do not have. They claim to be seeking greater regulation to protect the public from unforeseen losses. However, Bitcoin advocates assert that one of its values is in the way that Bitcoins are verified by the ledger in the block chain without the need for a third party or government, which minimizes the risks to users. This polarized debate is likely to continue, and each time that a new law or regulation is proposed the price of Bitcoin will likely adjust. Like any asset it will be subject to traditional market forces that include governmental action.
Notably, while many headlines have been made by the increased acceptance of Bitcoin by merchants, this news has not significantly impacted the value of Bitcoin. It remains to be seen whether acceptance by some of the e-commerce giants like Amazon or Alibaba will move the market, but – for example – the recent announcement that Dell will accept Bitcoin had no measurable effect on price.
For financial and investment professionals, advising clients on Bitcoin poses some challenges but for those who understand the market there may be gains available.