Cryptocurrency is digital (or virtual) currency that is not hampered by centralized government regulations, and its value is not dependent on or manipulated by things such as inflation. Bitcoin is the most popular and the first widely accepted cryptocurrency developed (in 2009), and to date represents the largest blockchain of its kind. Investing in Bitcoin is a hot topic right now due to its steady climb in value due to its significant rise in value from its inception.
The basic fundamental of cryptocurrency platforms is that they are self-regulated by users to ensure they are stable and to prevent double spending. This transparency creates the platform’s longevity to ensure its value as a viable currency or asset within the broader scope of e-commerce.
Although Bitcoin is a household name due to its recent sky-rocketing cost, there are other virtual currencies worth noting, including Dash, Litecoin, Ripple, and Ethereum. Also, while the use of the word “bitcoin” is commonly used to refer to all virtual currency, the proper name for them is “altcoin” as in an alternative to Bitcoin.
How Bitcoin works and how it’s stored after purchase
Wallets store your proof of bit ownership along with the private, encrypted keys that prove ownership and facilitate transactions. These wallets come in different forms from digital to paper and other types of wallets meant to keep your encrypted keys safe. Whichever storage method you choose, understand that if you lose the encrypted keys you’ll be in a mess because they prove your ownership of the cryptocurrency you’ve acquired.
Blockchain technology is the public ledger that stores the transaction information that follows and links your bits from the time you purchase them until you use them. Even though your ownership of bitcoin is anonymous, your use of them is completely transparent and public, which creates the self-regulating aspect of buying and spending. Transactions on the blockchain must be audited in order to validate bit ownership and confirm the holder’s right to spend it. This chain-linking method is called hashing and becomes more complex and time consuming as more people try to complete the process first.
Mining is the public process by which transactions are verified and added to the blockchain when purchasing and spending Bitcoin. Auditors, (also known as miners) are rewarded in bits for each transaction they verify. The speed in which mining is performed is called a hash rate. Obviously, the faster the hash rate, the better the chance of the miner completing the mining on the blockchain first.
The fact that cryptocurrency is anonymous and largely unregulated by governmental process allows for easy transactions and investing on a global scale—making it an attractive commodity for many reasons.
What’s the big deal about investing in Bitcoin?
Only 21 million Bitcoin can ever be produced. Roughly half of all that amount is already in play.
However, the fact that there’s a limit helps solidify its value and for many investors—makes an exciting asset to add to their portfolios.
The investment is attractive because it is new technology and Bitcoin’s popularity makes it easy for people to see where altcoins started and to compare their performance today. As mentioned, there are many different altcoins to invest in, and people want to get involved before the selling prices escalate.
How do you invest in Bitcoin?
- Buy and trade it on bitcoin exchanges like you would forex
- Invest in the miners/mining platforms
- Invest in Bitcoin Trust, ETFs, and hedge funds
The bigger question is, how do these assets work in self-directed IRAs?
You’re able to invest in Bitcoin and other virtual currency in your IRA. According to Section 4 of the Internal Revenue Bulletin 2014-16, Notice 2014-21, cryptocurrency falls under the general rules for property transactions. As such, it is treated just as any other asset in your portfolio for federal income tax reporting in the United States. Its earnings in your retirement plan enjoy the same tax-sheltered status that all your other assets do, even though it’s not an asset you can physically touch.
Buying and trading, as well as investing in Bitcoin Trust, ETFs, and hedge funds is self-explanatory. But, investing in the miners/mining platforms offers an interesting possibility in earning returns on your investment. Bitcoin transactions must be audited to verify the user’s ownership to use them. This audit connects past expenditures to future use by connecting these transactions in a public blockchain.
The typical rules of investing with IRAs apply. These are defined in IRC 4975, and include restrictions such as buying from and selling bitcoin to disqualified persons. You also cannot use any bitcoin you’ve purchased as an investment to pay for goods are services. Remember, assets and their gains in your portfolio can only benefit you upon retirement and not before. Just like you can’t vacation in a rental owned by your IRA, you may not use Bitcoin for any personal purpose until you retire and begin taking distributions within compliance of IRS regulations.
Due diligence is critical
Before investing, make sure you study all the ins-and-outs Bitcoin and other cryptocurrency present. There are two sides to every coin, you know. And, although many an expert feels that Bitcoin itself is in a bubble, which may soon burst, others believe it will reach 100K. Depending on your intent for investment purposes, only you can decide if it’s a good fit for your portfolio.
Also, while there are many platforms to choose and use, make sure you pick one that accommodates investments in IRAs and doesn’t require the acquisition to be personally guaranteed. Remember that when you invest with self-directed accounts—you are prohibited from personally guaranteeing any asset in your plan.
Additional reading: Top 10 Bitcoin Facts that You May Not Know (but Should)