Decrypting Bitcoin
30 Aug 2018
Are Bitcoin and cryptocurrencies just too risky for retirement investing?
Intrigued by the possibilities offered by Bitcoin and other cryptocurrencies but wondering if they are worth a punt? As with any other potential investment, it’s important to fully understand it before you put your money down.
While Bitcoin was the first kid on the cryptocurrency block, others to follow in its wake include Ethereum, Litecoin and Ripple. To recap how they work, see the box Decoding Cryptocurrencies opposite.
You might expect you should be able to use an alternative currency
to buy goods and services. But as coinmap.org shows, there are still limited places in Australia where you can pay for something with Bitcoin. They tend to be small businesses such as an art gallery, a tour operator or a cafe.
Major businesses have been slower to accept Bitcoin. Some, such as Dell and OkCupid, gave it the nod and then withdrew acceptance.
People mainly buy Bitcoin and other cryptocurrencies because they think they’ve spotted an investment opportunity. But, as with any other emerging market, that means they’ve had to be prepared to hang on tight through periods of intense price volatility.
“Cryptocurrencies should be viewed as a punt, much the same as a purchase of a non-profitable mining company on the stock market,” says David Leslie, a senior financial adviser at Morgans. “Be prepared that you may lose a significant amount of what you put in.”
Transaction costs and times have also been concerns for people who have jumped into cryptocurrencies. As the Bitcoin blockchain grows, the time needed to process a single transaction is lengthening (one of the reasons why other cryptocurrencies have appeared). The price volatility means investors can potentially pay a lot more than they intend or cash out for less than they hope when they decide to buy or sell.
Apart from the impact of price volatility, there are other risks that need to be considered before investing in cryptocurrencies. One of them is related to the exchange platforms on which digital currencies are bought and sold. Because these are not regulated, if the platform fails or gets hacked, investors are not protected and will have no legal recourse. Likewise, if your digital wallet is hacked, you have no protection.
Another thing: don’t assume that cryptocurrencies are escaping the attention of the taxman. If the cost of your digital currency is less than $10,000 and you’re only using it to buy personal goods and services, you won’t be taxed. Where the ATO becomes interested, however, is if people are treating digital currencies as an investment. In that case, it proposes to tax capital gains as it would with any other investment. If the currencies are being traded for profits, the profits will be treated as assessable income.
Decoding cryptocurrencies
Bitcoin and Ethereum are examples of cryptocurrencies. Rather than being a physical note or coin, they are a digital token created from code using an encrypted string of data blocks, known as a blockchain.
A blockchain is a decentralised database that can be accessed by all users. Users earn
or create blocks (or units of a digital currency) by solving complex cryptographic puzzles and verifying transactions. This is known as mining.
The blockchain keeps track of the ownership of the currency units and holds a history of every transaction ever made on the blockchain.
Cryptocurrencies are held in a digital wallet and units can be bought and sold on an exchange platform using conventional money. Some retailers can accept payment with cryptocurrencies in store via mobile devices, and Bitcoin can also be bought and sold for cash via Bitcoin ATMs.
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