- Financial advisors are fielding more questions from clients about bitcoin and cryptocurrencies.
- The IRS classifies cryptocurrency as property not currency, and taxes it accordingly.
- Exchanges such as Coinbase and companies such as Bitgo now specialize in helping bitcoin owners secure and manage otherwise unregulated accounts.
In 2010 Ashley Foster, a financial advisor in Houston, was asked by a man if he had ever heard of bitcoin. Foster said he had not, and after the man explained the cryptocurrency to him, he thought: That's the dumbest thing I've ever heard.
But the conversation left Foster a little curious, so he arranged to meet a man at a nearby Starbucks to try it out. There, Foster handed the man $300 in cash, who in turn opened his laptop and sent him two bitcoins. As Foster drove away, he thought: That was a little sketchy.
Today those two coins are worth $16,000. And cryptocurrencies are more mainstream.
Foster and many other financial advisors are fielding more and more questions from their clients about cryptocurrencies. There are dozens of exchanges where people can buy the digital coins. The Internal Revenue Service has classified bitcoins as property, like stocks, and taxes them accordingly. Last month the Chicago Mercantile Exchange, the world's largest derivatives exchange, announced it will allow investors to trade and short bitcoin. There is even a custodian service that will protect your digital fortune. About 40 percent of people believe bitcoin is a "world-changing technology," according to a new survey by LendEdu.
And yet there are still a number of barriers standing in the way of cryptocurrency's legitimacy. The survey also found that 44 percent of bitcoin holders "routinely worry about the technological security of their investments."
Many of the lasting concerns about cryptocurrencies seem inevitable. Its creators were looking to exchange money in a territory free from rules and regulation.
Cryptocurrency proponents argue that the digital coins are a safe investment because they have a "zero correlation" to the stock market. As a result, a dose of cryptocurrency makes investors' portfolios less volatile.
"We're starting to see bitcoin as a disaster hedge to the traditional market," said Chris Burniske, co-author of Cryptoassets: The Innovative Investor's Guide to Bitcoin and Beyond. "Even though there's a bull market now, it doesn't mean that'll be the case in 2018."
But David Yermack, who teaches classes on bitcoin at New York University's Stern School of Business, said the digital coins' uniqueness brings its own risks.
"In terms of diversification, it's useful to have a little in your portfolio, but the fact that you don't understand why it's moving doesn't mean it's safe," he said. "If anything, the lack of explanation should make you more hesitant."
Still, Yermack believes that cryptocurrency, and the so-called blockchain technology on which it's exchanged, will only become more understood and widely used with time.
"It's going to be a profound change," he said. "Every central bank in the world has a team of people looking at this."
In 2013 then Federal Reserve Chairman Ben Bernanke wrote in a letter to Congress that bitcoin "may hold long-term promise, particularly if the innovations promote a faster, more secure and more efficient payment system."
There's one big reason the government likes cryptocurrencies, Yermack said. "It takes away the ability of people to launder money or evade taxes, because you have a ledger of everyone's activity," he said. "This whole asset class is the dream of government."
Currently, only a small percentage of people are reporting their cryptocurrency gains and losses on their tax returns. Last year the IRS summoned information on users from Coinbase, the country's largest bitcoin exchange, after just around 800 people listed the currency on their annual returns.
Since the IRS classifies bitcoin as property rather than currency, gains and losses are to be taxed at the individual's capital gains rate. As cryptocurrencies become more popular, Yermack said, it will become riskier to avoid paying taxes on them.
"I would always comply with the tax law," he said. "In the cryptocurrency economy, you're leaving a roadmap for the IRS to come and get you."
While most banks and credit agencies offer security protections on consumers' accounts, there is no so-called middleman to rely on with cryptocurrencies.
"The greatest thing about cryptocurrencies is that you own your own keys," said Mike Belshe, co-founder of BitGo, a bitcoin security platform. "That's also the most terrifying thing about cryptocurrencies."
Afraid of theft, many people create complicated passwords for their accounts, which they can end up forgetting. Since they are the only one with access to their account, they risk losing their assets, Belshe said.
For people buying relatively small amounts of the digital coins, he said, Coinbase is the best exchange. "They hold the bitcoin on your behalf, and when you ask for it, they give it to you."
Other companies, like BitGo, offer additional protection. The service provides users with a "key card" that can be used to unlock one's money if they forget their password or find themselves locked out of their account for any other reason.
But security will become more expensive for people buying large amounts of the currency. Kingdom Trust is the first custodian that will hold cryptocurrency assets. At their facility in Murray, Kentucky, a person can make arrangements associated with traditional assets, like what will happen to their cryptocurrency when they die. Although Kingdom Trust is the first of its kind, Belshe said, "within a year, there will be a bunch."
Last year a client told certified financial planner Erika Safran, founder of Safran Wealth Advisors, that she was buying $100,000 of bitcoin. The woman suggested that Safran do the same.
But since Safran had never heard of the currency, she decided against it. "Now she has a million dollars," she said about her client. In the last few months, Safran has had four other clients invest in the digital coins. And now she has, as well.
"This refutes Warren Buffett's advice to not invest in anything you don't understand," she said. "With technology becoming so much more sophisticated and doing things we've never dreamed of, I don't know if we want to define the future by what we know today."