5 Cryptocurrency Pitfalls to Discuss with Your Clients
Between the stories we see on the internet, the countless memes, and the growing library of buzzwords, the topic of cryptocurrency is making an appearance during more client review sessions these days. As a financial advisor, having a plan for this conversation helps keep the conversation level-headed and informative. Today, we’re talking you through 5 simple (but important) conversation points to go over with your clients.
Defining Cryptocurrency
To make sure your clients are working from the same dictionary, it’s good to start the conversation by establishing a simple definition.
According to the FTC, cryptocurrency is a type of digital currency that exists electronically. In theory, people can use crypto like the way they use cash. They can invest in it, use it to buy things, and keep it in their (digital) wallet.
But as with any investment or currency (which is it?), there are a few pitfalls to make your clients aware of before they consider jumping headlong into the world of crypto. Here, we outline some of the most significant drawbacks to highlight to any interested clients.
Cryptocurrency could be a sound investment for one person and not a good fit for another. It’s important to educate your client on whether or not it is an appropriate investment for their financial goals.
1. Crypto Headlines Focus on Big Promises
It’s difficult to find an article about cryptocurrency that doesn’t contain hyperbolic claims about the currency’s performance. An article from Bloomberg shares some tweets from bitcoin fanatics that say crypto will be the world’s biggest benefactor is the “only monetary asset ever, has saved lives, and may one day hit $100,000 or even $1M a share.”
To an uneducated investor, all of these claims might sound like magic. Even if they doubt the headlines, it can be hard to find clear resources that discuss more realistic projections. But, as with any asset, it’s important to remind your client that we can’t see into the future, and we have no idea how it will perform in the coming years. They should approach these claims as hesitantly as we all would those regarding any other asset.
As a part of their financial plan, we recommend emphasizing the speculative nature of the asset and caution them against using it as a vehicle to accomplish their essential financial goals.
2. Crypto Is Still Not FDIC-Insured (and Why That Matters)
Another pitfall is that cryptocurrency accounts aren’t backed by the government like traditional bank accounts. There are some third-party private companies where people can store their digital wallets, but if something happens to those companies, the government has no obligation to step in to help them get their money back.
In addition to not being backed by government protection, most cryptocurrency payments don’t come with legal protections like credit or debit card purchases do. If someone needs to dispute a purchase they made using crypto, the process could be long and complicated, if not impossible. In addition, most purchases using crypto aren’t reversible. This lack of purchase protection and insurance could be a deal-breaker to some.
3. Crypto Is Often Less Secure
Because Cryptocurrency is stored online, it comes with some inherent security risks, both on- and off-line. For example, there’s always the risk of cybersecurity breaches, hacking, fraud/market manipulations, and other technological risks.
Just as important, there are also human error risks that one should consider before purchasing crypto. What would happen if your client forgot their password or someone stole their laptop? How would they access their digital wallet? The New York Times famously covered the story of Stefan Thomas, a German-born programmer who had two attempts remaining to guess the password to his digital wallet worth $220 million at the time of writing. Cryptocurrency and digital wallets give a new meaning and horror to the prompt “Forgot your password?”
4. Crypto Has Major Environmental Impacts
Even though cryptocurrency is digital, mining for crypto has real-world impacts. For investors who are environmentally conscious, this is an important point in the decision-making process. Mining requires huge amounts of electricity, and while electricity itself is a relatively clean source of energy, the countries with the highest rates of mining burn fossil fuels to generate electricity.
According to the Cambridge Bitcoin Electricity Consumption Index, mining for Bitcoin uses more power globally than entire countries, including the Netherlands, the Czech Republic, and Pakistan. And that’s just for Bitcoin, which is a single form of crypto. Mining for Ethereum generates more than 62.9 million tons of carbon dioxide emissions, the same amount as Serbia and Montenegro combined. According to Digiconomist, a single Bitcoin transaction uses as much power as it takes to run the average US household for over 78 days.
This environmental impact is a major consideration, especially as more investors are moving in the direction of environmental, social, and governance (ESG) investing.
5. Crypto Still Has to Prove Its Case
Lastly, cryptocurrency is still relatively new and needs more time to prove its case. Your clients can buy more things with crypto now than they could in past years, but it’s important to remind them that they can’t buy everything with crypto. In March 2021, Elon Musk said that Tesla would accept Bitcoin as payment but later stated that the company would no longer accept Bitcoin, due to its environmental impact.7 This is just one example of the instability of using crypto as a payment method. Cryptocurrency is a major player in today’s economy, but it’s worth helping your clients take the time to consider its drawbacks before jumping in.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which Investment(s) may be appropriate for you, consult your financial advisor prior to investing. Information is based on sources believed to be reliable, however, their accuracy or completeness cannot be guaranteed. Statements of forecast and trends are for informational purposes and are not guaranteed to occur in the future. There is also no assurance that any investment strategy will assure success or protect against loss.
Investment Advisory services are offered through WealthPlan Investment Management, LLC (“WPIM”). WPIM and WealthPlan Partners (“WPP”) are both registered investment advisors and subsidiaries of WealthPlan Group, LLC.