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Cryptocurrency Investing: 9 Facts Investors Should Care About

There’s no doubt cryptocurrencies like Bitcoin are becoming more and more popular. Crypto investing is evolving from people making speculative bets on a technological novelty, to a well-researched component of many investor portfolios. But it’s still a relatively young asset class, not to mention the fact the concept of digital assets is incredibly unique. Here are nine of the most fascinating and important facts about cryptocurrency investing you need to know.

1. Cryptocurrencies, especially buying Bitcoin, have gained the interests of the smart money.

Institutional investors are increasingly demanding access to digital currencies. Interest from the so-called smart money typically helps legitimize and increase the value of any asset or individual investment. Some of the notable investors delving deeper into crypto investing are:

- Billionaire hedge fund manager Paul Tudor Jones, who revealed in May 2020 that he holds almost 2% of his assets in Bitcoin.

- Grayscale Investments currently owns roughly 400,000 Bitcoin and purchases over $100 million dollars worth each week, putting it on track to own 3.4% of all Bitcoin by January 2021. Grayscale also holds about $4 billion worth of Ether (ETH).

- Fidelity Investments conducted a survey of 774 institutional investors in June 2020 and found that 36% own cryptocurrencies or derivatives. Even more important for the future, 80% say they see something appealing in the digital asset class.

- Through the first half of 2020, more than 20 financial institutions, ranging in assets from $10 million to more than $5 billion, revealed they owned bitcoin via the Grayscale Bitcoin Trust, a publicly traded investment vehicle that owns Bitcoin and loosely tracks its price.

- In October 2020, payments company Square invested $50 million in Bitcoin in order to diversify its largely USD-denominated balance sheet, becoming the latest large institution plowing big money into the world's first cryptocurrency.

2. Be prepared: digital currencies can be exceptionally volatile.

Unlike a typical stock market, trading occurs on various cryptocurrency exchanges and even on blockchains themselves rather than a central exchange. With pricing information flowing through multiple venues globally, volatility can be heightened. As a result, the price of Bitcoin has at times moved very rapidly.

For example, one Bitcoin reached $19,738 in late 2017, climbing 15-fold that year alone amid a flood of media headlines and surging adoption. By the end of 2018, the price of Bitcoin had declined 80%. In early 2021, Bitcoin’s value was more than two-times the price it hit in 2017, just north of $40,000.

While Bitcoin’s peaks and troughs can sometimes be very sharp, it’s important to note the asset’s overall trend over the long-term remains steadily higher. Newer assets tend to experience extreme volatility as investors go through the price-discovery process. That process often involves rapid moves, but itself does not disqualify the utility of the asset. The cannabis industry is experiencing a similar phenomenon.

3. The attraction: cryptocurrencies have no traditional fundamental backing.

Unlike the cash in your wallet (for those of you who still use cash, at least), or any other so-called fiat currency around the world, digital currencies are not backed by a central bank or government. This decentralization is a major piece of why many investors are attracted in the asset class. Digital currencies have no underlying assets, tax base or earnings power to determine a fundamental valuation. The valuation process of the assets is itself novel.

When you look at a public stock, you can use the company’s earnings history to estimate its value. The economic performance of a country, through measures like GDP and bond yields, help determine the value of a currency. But digital currencies have no traditional fundamental ties.

When it comes to Bitcoin, supply plays a significant role in pricing. Bitcoin has a fixed supply of 21 million, with roughly 88% of that already in circulation. The rest will come online over the next 120 years on a known and fixed schedule, which is a major difference from the supply of gold, the traditional asset that’s often compared to cryptocurrencies.

When investors want more gold, miners can increase production to meet that demand. When investors want more Bitcoin, there is no comparable ability to boost supply. Bitcoin is the first store of value where supply is unaffected by demand. Increased demand for Bitcoin has a major effect on it price.

4. Cryptocurrencies are banned in multiple countries.

Cryptocurrencies are decentralized and unregulated, especially compared to traditional fiat currency. That scares the pants off governments and bureaucrats, which have chosen to prohibit their use, typically by regulating so-called on-ramps – the exchanges. Some countries have outright banned the use of or the trading of digital currencies. Trading, making payments or buying goods and services with digital currencies is illegal in Bolivia, Ecuador, Nepal and Pakistan, among others. While some jurisdictions have soft bans on banking with cryptocurrencies, like Colombia, China, Saudi Arabia, Russia and even Canada.

5. Don’t forget! Cryptocurrencies are subject to tax.

Just because cryptocurrencies are decentralized, it doesn’t mean the government doesn’t want to get a piece of your action. In Canada, digital currencies are subject to the Income Tax Act. The Canada Revenue Agency treats Bitcoin and other crypto assets as a commodity, not a currency. When you engage in cryptocurrency investing, any gains or losses are taxed in the same fashion as any other commodity investment. Depending on how you’ve structured things, gains from disposing cryptocurrency may be either business income or a capital gain and should be reported as either property income or business capital.

Cryptocurrencies are subject not only to investment taxation, but also transactional taxes. Bitcoin and other crypto assets are not considered legal tender, but the CRA recognizes that it can be used to pay for goods and services. Because crypto assets are a commodity, transactions with them are considering bartering. The CRA says barter transactions fall under the scope of the Income Tax Act, meaning businesses have to recognize income on a sale purchased with cryptocurrency and have an obligation to collect and remit sales tax.

While the taxation of crypto has largely gone under the radar, relative to other assets, a rude awakening may be coming. In the U.S., the Internal Revenue Service reported that only about 800 taxpayers claimed gains on their crypto assets between 2013 and 2015, which means many people are either willfully or mistakenly sidestepping the law.

6. Increasingly, investors are using cryptocurrency to hedge against inflation.

Bitcoin has become one of the most popular ways to hedge against long-term inflation worries, which have resurfaced due to the massive stimulus packages we’ve seen deployed by central banks and governments around the world. Some believe that the emergency measures taken to combat the economic impact of COVID-19, particularly money printing, will reduce the value of traditional fiat currencies. Digital assets like crypto are thus seen by many as an alternative to gold. Other trends, like increased global trade, digitization and rising crypto adoption among younger consumers, are making investors consider cryptocurrency as a hedge against traditional currencies.

7. It’s not just the kids: the rich are taking notice of crypto.

DeVere Group, a global financial advisory firm, says that 73% of its millionaire clients who responded to the firm's annual cryptocurrency survey are already invested in or will invest in cryptocurrencies by 2023. That’s up from 68% last year as high-net-worth individuals rebalance their portfolios toward crypto.

8. Beware of impending regulation on cryptocurrencies.

Investors speculate that if Bitcoin and the crypto asset universe continues to get bigger, it will become more regulated. Around the world, this is already happening little by little. For example, there’s enhanced regulation in a number of countries which bars financial institutions from facilitating cryptocurrency transactions.

In the US, The SEC has largely cracked down on crypto fundraising through "initial coin offerings," but it's been hesitant to issue guidance on the industry as a whole. That could soon change.

"There is more and more interest from a wide spectrum of people, both inside the crypto space as well as inside the traditional financial institutions, who are asking us for guidance," an SEC Commissioner told CoinDesk in late 2020. "I think we're going to be forced to confront that more and more in the coming years."

9. The pandemic is turning more attention to Bitcoin.

Amid a pandemic that's put significant pressure on the US dollar, the price of Bitcoin has exploded. In 2020, the cryptocurrency tripled in value. Within the first two weeks of 2021, Bitcoin rallied further by more than 30%. The moves have renewed attention from Wall Street and the financial media, especially as the price of Bitcoin smashed its previous peak price in late 2017 (before the crypto market infamously crashed). Even major investment news sites now track the price of Bitcoin, Ethereum and other crypto assets daily.

All data sourced to Bloomberg unless otherwise noted.

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