What Are the Advantages of Paying With Bitcoin?
Due to the unique nature of virtual currencies, there are some inherent advantages to transacting through bitcoin over fiat currencies. Although over a decade old, the digital currency landscape is constantly changing, with most tokens being untested as a medium of exchange, and users should be careful to weigh their benefits and risks. That said, bitcoin is designed to offer users a unique set of advantages over other payment methods. We’ll take a closer look at those below, but before we do, it will be useful to explore what bitcoin is. By better understanding how bitcoin was designed, it will be easier to see what the advantages of using bitcoin for payments are.
What Is Bitcoin?
Bitcoin is a decentralized, peer-to-peer cryptocurrency system designed to allow online users to process transactions through digital units of exchange called bitcoins (BTC). Started in 2009 by a mysterious entity named Satoshi Nakamoto, the Bitcoin network has come to dominate and even define the cryptocurrency space, spawning a legion of altcoin followers and representing for many users an alternative to government flat currencies like the U.S. dollar or the euro or pure commodity currencies like gold or silver coins.
Why the need for bitcoin in the first place, if there are already so many traditional means of making payments? A key element of bitcoin is its decentralized status, meaning that it is not controlled or regulated by any central authority. This immediately distinguishes it from fiat currencies. Bitcoin payments are processed through a private network of computers linked through a shared ledger. Each transaction is simultaneously recorded in a “blockchain” on each computer that updates and informs all accounts. The blockchain serves as a distributed ledger and obviates the need for any central authority to maintain such records.
Bitcoins are not issued by a central bank or government system like fiat currencies. Rather, bitcoins are either “mined” by a computer through a process of solving increasingly complex mathematical algorithms in order to verify transaction blocks to be added to the blockchain, or they are purchased with standard national money currencies and placed into a “bitcoin wallet” that is accessed most commonly through a smartphone or computer.
Benefits of Bitcoin
Now that we have seen a brief overview of what bitcoin is, we can better understand how this leading cryptocurrency provides potential benefits to its users.
1. User Autonomy
The primary draw of bitcoin for many users, and indeed one of the central tenets of cryptocurrencies more generally, is autonomy. Digital currencies allow users more autonomy over their own money than fiat currencies do, at least in theory. Users are able to control how they spend their money without dealing with an intermediary authority like a bank or government.
Bitcoin purchases are discreet. Unless a user voluntarily publishes his Bitcoin transactions, his purchases are never associated with his personal identity, much like cash-only purchases, and cannot easily be traced back to him. In fact, the anonymous bitcoin address that is generated for user purchases changes with each transaction. This is not to say that bitcoin transactions are truly anonymous or entirely untraceable, but they are much less readily linked to personal identity than some traditional forms of payment.
3. Peer-to-Peer Focus
The bitcoin payment system is purely peer-to-peer, meaning that users are able to send and receive payments to or from anyone on the network around the world without requiring approval from any external source or authority.
4. Elimination of Banking Fees
While it is considered standard among cryptocurrency exchanges to charge so-called “maker” and “taker” fees, as well as occasional deposit and withdrawal fees, bitcoin users are not subject to the litany of traditional banking fees associated with fiat currencies. This means no account maintenance or minimum balance fees, no overdraft charges and no returned deposit fees, among many others.
5. Very Low Transaction Fees for International Payments
Standard wire transfers and foreign purchases typically involve fees and exchange costs. Since bitcoin transactions have no intermediary institutions or government involvement, the costs of transacting are kept very low. This can be a major advantage for travelers. Additionally, any transfer in bitcoins happens very quickly, eliminating the inconvenience of typical authorization requirements and wait periods.
6. Mobile Payments
Like with many online payment systems, bitcoin users can pay for their coins anywhere they have Internet access. This means that purchasers never have to travel to a bank or a store to buy a product. However, unlike online payments made with U.S. bank accounts or credit cards, personal information is not necessary to complete any transaction.
Cryptocurrency terms for financial advisors to know
Before we get into the discussion of how financial advisors can add cryptocurrency to a client’s portfolio, let’s start with some basic definitions.
- What is money?
- What is a fiat currency?
- What is Bitcoin?
- What is Blockchain?
- What is an NFT?
- What is a Blockchain miner?
Money: Money is a medium of exchange whose value has traditionally been transferred as payment for goods or services from one party to another through coins and bills.
Fiat currency: Way back in days of yore, the dollar was pegged to gold. Then FDR made the dollar unpegged to gold. You could create extra money without creating any underlying value to go with it. Nixon did away with the gold standard 100%, and the US dollar became a fiat currency, backed only by the full faith and taxing authority of the US government.
Blockchain: Blockchain is not some mythical creature like Narnia. It’s simply a shared database with many actors. If you were to walk into a bank and deposit $100 and the transaction were on the Blockchain, they would write an entry into that database. Another bank on the Blockchain could also see it. Other banks could verify that transaction. That’s all Blockchain is, a shared database.
There are private blockchains, and public blockchains. The example described above is a private blockchain. They are in production at the time of this podcast. Examples of public blockchain would be Bitcoin and Ethereum where if you have a computer and an internet connection, you can download all the transactions that are on the Bitcoin blockchain. You can see on there a transaction from one wallet to another public wallet with a time stamp. It is as if you gave someone $20 on the street, and there are 10,000 people witnessing that transaction.
Blockchain miner: Someone who approves Bitcoin transactions. Imagine there are 10 people sitting in a room, and they’re all sitting at a desk with a 1,000 piece puzzle in front of them. Eventually someone is going to solve that puzzle. Once that is done, everyone can look at the puzzle and say, “Oh yes, that’s a square.” Everyone can agree it’s a square, but solving the puzzle is extraordinarily difficult and expensive.
The Blockchain miners do not hold the digital assets; a custodian does. Or, you could have your own hardware wallet which for the record A.J. does not recommend. The latter case is commonly referenced when you hear stories about people losing their money because they forget their passkey.
Cryptocurrency: A digital currency that is encrypted and decentralized (not relying on what the central bank does). There are many different types of cryptocurrencies such as Bitcoin, Ripple, and Ethereum. Not all cryptocurrencies are created equal – the security, regulation, and history involved with each are worthy for investors to take note of.
Just like any capital market instrument, a cryptocurrency’s value changes based upon supply and demand for the asset.
Bitcoin: See definition of Blockchain above.
NFT: Non fungible token. Several decades ago, people were ripping off music during the Napster era and there was no way to prove that you were the only person who owns that digital asset. There was no way to make it scarce.
An NFT is a digital asset that sits on a Blockchain. It could represent something physical like art, or it could represent a digital file like a famous tweet. You are the only one with that item.
TDAMP: Turnkey digital asset management platform. A technology platform that allows investors to invest in digital assets. You have an account on this platform that is reported upon, and data from the platform can be exported into other systems.
Why would someone invest in cryptocurrency for themselves or for their clients?
Before we get into how financial advisors can add cryptocurrency to a client’s portfolio, let’s talk about why financial advisors (and the world at large, it seems) is curious about cryptocurrency. While performance of any asset can never be guaranteed, and nothing in this blog and/or podcast can be interpreted as investment advice relevant to anyone specific, there is a belief that cryptocurrencies are going to change the way that society functions in three major ways.
#1 Store of value/universal currency of exchange
Some people believe that banks and governments can’t be trusted, and cryptocurrencies are potentially going to be the new global reserve currency with goods and services being priced in cryptocurrency. Companies and people are starting to use cryptocurrency as a store of value.
#2 Inflation hedge
There is an idea prevailing that fiat currencies are being devalued and inflation is due to rise, as a result of all the stimulus money that has been printed and other economic factors. There is a finite amount of Bitcoin, for example, that can be created.
#3 Potentially low correlation to the market
Cryptocurrencies have become attractive to some as a potentially diversifying alternative investment because of their alleged zero correlation to the market. Such diversifying investments can potentially lower overall portfolio volatility, if managed appropriately in accordance with the investor’s risk tolerance.
#4 Some financial advisors have found that being knowledgeable about investing in cryptocurrency is a way to bridge the gap with younger generations of their clients’ families.
All of these are potential ways that cryptocurrency may have an impact in the future – none of them are certain.
What are the issues and obligations for advisors who want to invest in cryptocurrency for their clients?
As a financial advisor, you have responsibility to manage your clients’ assets prudently. If you are going to be investing in cryptocurrency for your clients, consult with your compliance and/or legal council and be aware of your obligations. Being prepared and through before doing so is a big part of the answer to how financial advisors can add cryptocurrency to a client’s portfolio.
Here are some of the issues to be aware of for financial advisors who are potentially investing in cryptocurrency for their clients. This is not an exhaustive list; there are others that may potentially exist.
#1 Check your errors and omissions insurance
Make sure investing in cryptocurrency for your clients is covered in your e&o insurance policy and any other insurances where this may apply. Make a phone call if you’re not sure. Some policies cover this already, and some don’t.
#2 Educate yourself about digital assets
Part of your responsibility is knowing what you are investing in for your clients in all circumstances. You must have a reasonable basis for making these and all other investments on behalf of your clients. You also need to be able to articulate and explain these investments to your clients in a way that enables them to understand clearly.
#3 Understand that not all digital assets are created equally
With certain cryptocurrencies, there is a gray area in terms of regulations that pertain to them. Some more than others. It may be more prudent to stick to cryptocurrencies that the SEC has already deemed as appropriate for investment.
#4 Encourage clients to report it correctly on their taxes
Ask your clients if they hold cryptocurrency, and if so, encourage your clients to report any tax events associated with cryptocurrencies when they file their taxes. Cryptocurrencies are treated as property. Just like any asset, an individual will be liable to potentially owe a short or long term gains tax if they recognized a gain over the cost basis that cryptocurrency was purchased at.
If your clients are at a loss to understand how to report cryptocurrency on their taxes, encourage them to consult a tax advisor.
#5 Disclose properly on Form ADV, especially Part Two
Digital assets are not necessarily one of the investable asset classes disclosed on your ADV. On your Form ADV, Part Two, there is a list of investments that you are able to invest your clients’ money in as a financial advisor. Have your legal and/or compliance team review it and determine the best way to disclose that you are able to invest your clients’ money in digital assets.
Again, this list is by no means exhaustive and may not be interpreted as specific to any one individual, so please consult your firm’s legal and compliance advisors for advice.
Should the same rebalancing strategy (tolerance bands or time interval) be applied to cryptocurrency as an asset allocation as other holdings?
Financial advisors should not make an exception for this asset class when it comes to rebalancing. Stay true to your strategy for rebalancing, whether it be bands, time intervals, or otherwise. You should never change your asset allocation strategy for any particular asset class.
How can a financial advisor add cryptocurrency to a client’s portfolio?
Now that we’ve covered the groundwork, how does an advisor actually invest in crypto for his or her clients? How can a financial advisor add cryptocurrency to a client’s portfolio? There are a few possible ways.
- Financial advisors might use a TDAMP to invest in cryptocurrencies for their clients. On such a platform, reporting is centralized for all clients. In the past, it was difficult to invest in digital assets for clients because you used to need a login for each client. A TDAMP must be approved by the financial advisor’s company and compliance before they can use it.
- GBTC, or Grayscale Bitcoin Trust™, has gathered some assets from financial advisors looking to invest in digital assets for their clients. This is a Bitcoin trust. It trades on an exchange. You don’t own shares of Bitcoin or Ethereum. You own shares of a trust, almost like a closed end fund. This is a proxy for cryptocurrency but it is not technically the same as investing directly in the cryptocurrency.
- It is also possible to invest in companies that are involved with Blockchain technology, or that hold cryptocurrency on their balance sheet. Again, you don’t own the asset directly in this case.
Some financial advisors are not interested in investing in cryptocurrency for their clients at all, and in these cases they would simply direct their clients to retail platforms for the clients to trade it themselves.