By Catherine Powell
|Image courtesy Pixabay|
FTX founder & CEO Sam Bankman-Fried indicted for fraud? Cryptocurrency player BlockFi filing for bankruptcy? A-List celebrities including Madonna, Justin Bieber, Paris Hilton, Jimmy Fallon, Serena Williams, & Kevin Hart named in class action lawsuit against cryptocurrency startup Yuga Labs? If you've invested in or are considered investing in cryptocurrency, you may wish to know how exposed you are to market volatility. You may also want to know if you can hedge your bet when it comes to crypto investments. If that's what's keeping you awake at night, here's what you need to know.
What is Cryptocurrency?
Unlike the dollar, the Euro, the yen and other traditional currency, crypto is 100% digital. The only wallet you need to use cryptocurrency is software-based. This wallet exists either on one of your devices such as a laptop, tablet or smartphone, or it resides in the cloud. The reason you need a cryptocurrency wallet is that this is not only where your currency resides, it's also the place where you store the encryption key that secures your investment, as well as letting you buy, sell, and make purchases using crypto.
What are the risks?
Unlike banks in the US that insure your deposits under FDIC guidelines, cryptocurrency is virtually unregulated. That means your deposits aren't federally insured. If a brand of cryptocurrency goes belly up or turns out to be nothing more than a Ponzi scheme, your crypto holdings could be wiped out overnight. The other thing that makes cryptocurrency a high-risk investment is that the value of any brand of cryptocurrency can fluctuate wildly. (In 2022, Bitcoin's value plummeted from a high of $50,000 to a low approaching $16,000 in less than a year?) While it's a good thing for investors when the price of their crypto investment rises, it can be a bad thing if the crypto you hold drops precipitously. Another thing you need to know going in is that unlike using another form of digital currency such as a credit card where you have recourse if the goods you purchase are faulty or never get delivered, when you use crypto to make a transaction, the deal is irreversible. Don't think it can happen to you? It did to Apple Computer co-founder Steve Wozniak in 2018. He admitted to losing more than $70,000 when he sold seven Bitcoins to a scammer who later reneged on the payment. The term caveat emptor, or buyer beware, applies doubly to cryptocurrency where buyers and sellers have to beware of getting ripped off.
Can crypto get hacked?
Yes it can, according to the FTC. Should the device or service that hosts your crypto wallet get hacked, your holdings could be siphoned off without your consent. There are hackers who make a fortune by luring unsuspecting consumers to their websites only to implant malicious software that they can later use to mine the cryptocurrency that traders have in their wallets. While firewalls, adware, and anti-malware can provide some level of protection, there's no sure fire way to protect cryptocurrency from determined hackers. CBS News reported in October that hackers managed to steal more than $3 billion in crypto this year alone. That figure is an increase of 30% from 2021. Not only were hackers able to hit individual wallets, they also managed to target Bitcoin ATMs and crypto exchanges including $620 million stolen from Ronin Network.
What can you do if you lose big on crypto?
While you can't recover any losses you suffer from mining crypto, according to CNN Business, investors are permitted by the IRS to use the loss to offset any capital gains they may have made during the calendar year or they can carry a portion of the loss to subsequent years.
"Say you bought bitcoin at $50,000 in February 2021, then sold it in mid-August of this year at $24,000, you’d have a long-term capital loss of $26,000, because you held the investment for more than a year. Then say you also booked a $10,000 capital gain by selling a long-held stock in a taxable brokerage account (i.e., not a tax-deferred account like a 401(k) or IRA). You can fully offset the tax owed on your $10,000 capital gain with $10,000 of your capital losses on your 2022 tax return. In addition, you also can use your losses to offset the tax owed on up to $3,000 of your ordinary income this year. Whatever losses that you don’t use up this year, you can still use in future years. So in the example above, you would use half your capital losses this year ($13,000) to offset your $10,000 capital gain and $3,000 in income. Then you can carry forward the other half of your losses into future years. And if you have a year where you don’t have any gains to offset, you can still use $3,000 of your losses to offset taxes on $3,000 of your income."
However, the article goes on to point out that you must use or lose the loss yourself. Even though the IRS considers cryptocurrency property as opposed to securities, traders aren't permitted to pass any losses along to their heirs.
Can you insure against losses with crypto?
Due to the ever escalating wave of cryptocurrency heists, some crypto exchanges have started offering a form of insurance that's designed to protect investors from some forms of theft. Coinbase insures their users against some forms of cybersecurity breaches, not to include illicit access to personal accounts due to a breach resulting from a user's loss of credentials. Since 2018, Binance has covered its users against some losses out of pocket, including a 2019 hack that cost the company $40 million. There are even a few insurance companies, such as Lloyd's of London who offer crypto policies designed to cover losses to exchanges. To date, no insurer offers coverage for individual losses. In the event that a cryptocurrency provider goes bankrupt, customers with custodial held assets are last in line to receive any payments, according to Investopedia. They recommend acquiring a non-custodial crypto wallet to protect any investment.
The insurance industry as a whole has yet to enter the cryptocurrency arena in any significant way. This is in part due to cryptocurrency being so new that the risks to insurers have yet to be calculated. The other issue is the complicated nature of the protection that would be required. To be effective, an insurance product for investors would need to be able to cover policyholders from losses of their crypto keys, as well as covering them for losses due to hacks or smart contract faults that transfer more cryptocurrency between parties than was intended. Until that happens, investors in cryptocurrencies are for the most part on their own.
Catherine Powell is the owner of A Plus All Florida Insurance in Orange Park, Florida. To find out more about saving money on all your insurance needs, check out her website at http://aplusallfloridainsuranceinc.com