Technology has changed how we manage our individual retirement accounts (IRAs). We no longer need to visit the offices of an investment firm to manage our accounts. We can do it comfortably from our homes.
What has largely remained unchanged since IRAs were introduced in 1974, are the types of investments we use to fund them. Until now, traditional forms of funding have included stocks, bonds, certificates of deposits and physical assets with value.
However, the world of investing is changing. Our world is becoming increasingly digital with each passing day, with a large portion of our lives now taking place online. It stands to reason that a digital currency and investment option would be ready to change the landscape.
What Is Bitcoin?
Bitcoin is a digital currency that exists on a blockchain, a public ledger, on the internet. As the public ledger uses cryptography to secure transactions, it is also a cryptocurrency.
No central authority, like a bank or government, updates the blockchain ledger. In place of a central authority, computers run the bitcoin core software in a peer-to-peer network and manage it through consensus.
The process of finding consensus on the status of the shared public ledger is known as “mining”. Every ten minutes, computers in the network compete to find a solution to a mathematical problem the bitcoin protocol provides.
The winning computer updates the ledger for ten minutes. It also keeps the new bitcoins released within that time—12.5 bitcoins.
A software developer by the name (or pseudonym) of Satoshi Nakamoto released the first version of bitcoin core software in January 2009. The first release came three months after Nakamoto published a white paper in a cypherpunk mailing list describing how the technology would work.
No individual, company or institution owns the bitcoin protocol as it is an open-source project. Software developers all across the world contribute to its improvement.
A complex ecosystem of mining operations, wallet services, exchanges and investment platforms has grown around bitcoin. Close to $2 billion has been invested into companies and startups offering related services. The cryptocurrency has grown to about $38 billion in market capitalization.
Bitcoin was the first cryptocurrency ever created. Since its creation, more than a thousand others have come into existence. All cryptocurrencies work with the same concept and technology, but have a wide range of differing features and use cases.
The most popular alternative coins (altcoins) include Ethereum, Litecoin, Ripple and NEM and Ethereum Classic.
Over 150,000 merchants worldwide accept bitcoin as payment for goods and services, mostly through payment processors like BitPay. Users can even use the cryptocurrency to shop on Amazon through the payment exchange Purse.io.
Bitcoin has the potential to be a unit of account. Individuals and organizations can use it to measure and track the worth of assets, price, expenditure and income. At the moment, the majority of users find it convenient to denominate items in fiat currency when using bitcoin.
The most popular use of bitcoin however is as a store of value. It is convenient for remittances, as it moves fast across borders. It is also a popular long-term investment asset.
Its price has grown from zero to above $3000 in a span of eight years. Someone who bought $400 worth of bitcoin in 2011 is worth over $1 million in 2017.
Advantages of Bitcoin as an Investment
Bitcoin’s supply is capped. There will never be more than 21 million in circulation. The number coming into circulation diminish when the new supply halves every four years. The network will mine the last coin in the year 2140. The deflationary nature of bitcoin has earned it the tag ‘digital gold.’
Meanwhile, the adoption of bitcoin is growing around the world as shown by each transaction the network confirms. The daily average was about 50,000 transactions in 2013. That number has risen to about 320,000 in 2017.
The diminishing number of new bitcoins coming into circulation, combined with expanding worldwide adoption, creates an environment for its value to continue to grow.
Another advantage of bitcoin as an investment is that you can hold it independent of a custodian. This gives you full control over your holdings and protects you from third-party mismanagement or fraud.
You can have full control over your bitcoins even when you use custodial services through multisignature wallets. The infrastructure allows for a wallet to have two or three separate private keys. All keys are needed in order for an authorized transaction to take place. A secure wallet provider like Bitgo keeps each key in a separate “cold storage” (or offline away from the internet) locations to ensure maximum security.
Bitcoin exists independently from assets such as stocks, savings and bonds. During an economic crisis, bitcoins do not fall in value with the rest of assets, but rather, they have historically increased in value in an inverse relationship.
Is Bitcoin Allowable by the IRS as a Retirement Asset?
Bitcoin is less than ten years old and most regulators around the world have not conclusively taken a position on the cryptocurrency. The USA is one of countries that have issued guidelines on its use.
In March 2014, the Internal Revenue Service (IRS) declared it would treat bitcoin as a commodity for taxation purposes, the way it treats stocks and bonds. The IRS has declared that Bitcoin will be regarded as a “property” and will thus require a custodian in order to comply with regulations.
Typical IRA custodians accept only mainstream assets such as stocks, bonds, mutual funds and certificates of deposits (CDs), as the IRS directs. The best option you have to include bitcoins in your retirement plans is to use a self-directed IRA, which allows you to invest in a cryptocurrency like Bitcoin.
When using a self-directed IRA, you can either buy and hold bitcoins, or buy shares of dedicated funds that hold them. The first option allows you to buy and sell depending on the price movement and earnings from the volatility. This requires you to acquire the skills of an asset or forex trader.
By investing in dedicated funds that hold bitcoins, you delegate decision making about when to buy and sell to expert investors.
Bitcoins can be bought from exchanges. These are companies that match buyers and sellers of cryptocurrencies. Genesis, Coinbase and Kraken are some of the exchanges registered in the US.
Where Is Bitcoin Stored?
A bitcoin wallet is an application that holds the private keys (digital signature) you use to authorise movement of coins assigned to you on the blockchain. If someone accesses your wallet, they can steal your bitcoins.
Different types of wallets exist. Some like Bitcoin Core, Armory and Electrum are decentralized. No individual or organization owns them. They run as open projects. Meanwhile, others like Blockchain.info, Coinbase and Xapo are centralized and run by profit-making businesses.
Decentralized wallets offer full control of your private keys and thus your bitcoins. Converseley, centralized wallets require you to trust administrators with your private keys.
Bitcoin wallets also fall into two broad categories: hot and cold wallets. Hot wallets are those that connect to the internet. Wallets in this category include apps downloaded to a to smartphone, signing into a web browser, and software downloaded to a laptop or desktop computer.
Cold wallets never come into contact with the internet, such (non-internet connected) desktops or USB sticks. This category also includes hardware wallets, which are separate devices designed to store bitcoins.
You can also generate a wallet and print it on a piece of paper through Bitaddress.org. Paper wallets are the most secure cold wallet, especially if you generate it offline and clean the computer and printer caches before reconnecting to the internet.
You can share the public address of your paper wallet with those who pay you. You need to secure the copy with the private keys in a safety deposit box, however, especially if it holds huge amounts of bitcoins.
Cold wallets are the most appropriate for long-term storage of huge amounts of bitcoin because they are not susceptible to remote hacking.
Should you invest in a Bitcoin IRA?
The best investment you can make is a mixture of all the available options. The more asset classes you invest in, the more you spread your risks. A Bitcoin IRA is a high-growth potential investment available to you to develop a diverse portfolio.
A Bitcoin IRA is a special investment because it is not linked to the other investment options such as finance, bonds and stock. In times of global economic crisis, bitcoin isn’t infected with the toxicity of the markets. The factors that influence its price are different, which adds to its value as an option to spreads your risks.
Like any investment, bitcoin comes with risks. Bitcoin is projected to continue growing in value, but, of course, there are no guarantees. There is also a possibility of its underlying technology failing. It could break while developers tweak the core software to improve user experience or to scale the size of network to meet demand.
How Do I Get Started?
There are two options available to you
- Do it yourself (such as setting up an LLC for IRS-compliance)
- Use experts to help (such as BitcoinIRA.com)
To set up a bitcoin IRA yourself you’ll need to take steps to ensure it is IRS-compliant, this includes setting up an LLC for your Bitcoins, however there are many risks to holding bitcoin in a self-directed IRA LLC, including a lengthy list of “prohibited transactions” that can disqualify the tax protection of assets within the IRA.
Legally, an IRA and its owner are separate entities and must act separately. The list of “prohibited transactions” is intended to prevent account owners from drawing double benefits from the IRA’s tax protection.
For example, account owners cannot put up the assets of their IRA LLC as security for a loan, since that would give them the double benefit of tax-protected assets and collateral.
Under these same rules, account owners cannot sell bitcoin to their own IRA LLC and must buy and store bitcoin in the name of the LLC, not their own names.
For investors who own bitcoin and want to transfer it into an IRA LLC, there’s only one option: sell the bitcoin, then contribute the proceeds — in U.S. dollars — to the IRA LLC, and then buy bitcoin in the name of the LLC with its own cash assets.
As with real estate and other unconventional investments, it’s also the responsibility of investors to report the fair market value of their assets to their custodian each year, whether those assets are held in an LLC or not.
For assets such as stocks and bonds, these values are assessed automatically. For real estate and unconventional investments like bitcoin, a third-party assessment is usually required.
If an account owner fails to report the value of their assets accurately to their custodian or engages in a “prohibited transaction,” their IRA can be disqualified and all assets distributed and taxed. Last but not least, account owners must also file annual reports and pay fees to the Secretary of State where the IRA LLC is incorporated.
Even if account owners cross all the t’s and dot all the i’s, bad custodians can still get them in trouble.
The best option to use a turn-key service that handles all the steps while ensuring security and IRS-compliance.
Recommended Service - BitcoinIRA.com
The majority of IRA custodians and trustees still either lack the technical capacity to add bitcoin to the options they offer, they are wary of its volatility, or they are waiting for clearer regulatory guidelines. Meanwhile, cryptocurrencies are growing and the advantage of being an early investor is slipping away.
BitcoinIRA.com was the first to offer this and remains the largest company in this space with a lot of strong customer reviews on Google and Facebook. They offer a full-service solution that assists investors in rolling over their existing retirement funds from one custodian to another, coordinating trades with a reputable exchange and securing their Bitcoins in a Cold Storage Wallet exclusively with Bitgo, a secure wallet service provider. They take a commission that varies based on your overall investment amount, however it’s reasonable given the risks and compliance issues involved.
Newer, lesser known services include PENSCO Trust Company, Millennium Trust Company and The Entrust Group. Some of these services provide help with do-it-yourself options, but the consumer bears greater risks with compliance and theft.