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Jan

2022

What Are Over-the-Counter (OTC) Options? Pros & Cons

What Are Over-the-Counter (OTC) Options? How Do They Work?

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

Over-the-counter (OTC) options are exotic options not listed on public exchanges. That means that investors may not be able to buy them through their brokerage accounts.

Instead, investors trade OTC contracts directly, between the buyer and the seller, without using a third-party platform.

OTC Options Definition

As a quick refresher, options are derivatives that give holders the right to buy or sell stocks or other assets. An options holder can buy or sell the asset at a certain date at a certain price, for instance, and are always tied to an underlying asset. So, an options trader can buy options relating to, say Stock A, or Bond X.

While most options trade through brokers via exchanges, over-the-counter options trade privately, between a buyer and a seller. Over the counter options are sometimes tied to an exotic asset — a stock that may not be available for purchase through most brokers’ platforms.

OTC options may also lack standard expiration dates or strike prices, instead allowing for the two parties to define those terms on their own, making them appealing to those with a more complex options trading strategy.

How Does OTC Trading Work?

OTC securities include any types of investments that do not appear on U.S. exchanges. That can include stocks in foreign companies and small or mid-sized domestic companies, over-the-counter options and OTC futures. Some brokerages do allow investors to trade OTCs on their platforms, though not all do, and there may be additional fees charged by the broker to do so.

With that in mind, if you plan on investing in the OTC market, you may need to do some research beforehand to ensure that the brokerage account allows for OTC trading. Once you’ve found the appropriate broker or platform, trading is as simple as funding an account, and executing the trade.

What is the Difference Between OTC Options and Stock Options?

OTC options and regular old stock options, or listed or exchange-traded options, have some key differentiators worth reviewing. Here is a short rundown of those differences:

OTC Options vs Stock Options

OTC Options	Stock Options
Customized	Standardized
Illiquid	Liquid
No secondary market	Secondary Market

1. Customization

A typical listed stock option is a standardized contract. The exchange, then, is determining expiration dates, strike prices, lot sizes, and other details. By standardizing contracts, exchanges can, as a result, increase the liquidity of the options contract.

Customization is the main and perhaps biggest difference between typical exchange-traded or listed stock options and OTC options. OTC options are customized with the terms hashed out by the involved parties.

2. Liquidity

OTC options are largely illiquid compared to their vanilla cousins. That’s because they’re more or less bespoke contracts — they’ve been customized according to the criteria set forth by the parties involved.

So, OTC options, with their customizations, may not be appealing to many traders, and as a result, not quite as easy to sell. In other words, there’s less demand for tailor-made options contracts like those in the OTC market, meaning they’re less liquid, and often more costly.

3. Secondary Markets

Another key difference between vanilla stock options and OTC options is the secondary market — or lack thereof, in the case of OTC options.

Primary markets are where investors buy fresh securities, when they’re first offered. Secondary markets are what most investors engage in when they’re buying or selling securities. These include exchanges such as the New York Stock Exchange.

While the primary market for OTC options is where parties meet to come to terms and develop an options contract, there is no secondary market. That means that there is one way to close an OTC option position, and that is by creating an offsetting transaction.

What are the Risks of Trading OTC Options?

Given the complex and bespoke nature of OTC options, trading them can come with some serious risks. Chief among those risks is the fact that OTC options lack the protection of exchanges. While exchange-traded or listed options are, once again, standardized, they are thus “guaranteed” by clearinghouses.

That means that they’re overseen, like other derivatives, by regulating authorities like the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). The guarantee cements into place that contract buyers can exercise their options, knowing that the counterparty will fulfill their obligation.

This is also known as counterparty risk. Essentially, a contract is a promise between two parties. If one party decides not to follow through on their end of the deal, when it comes to a traditional stock option, then the exchange will ensure that everything is smoothed out. But OTC options lack that protection from the exchanges.

Pros & Cons of OTC Options Contracts

Like just about every financial tool, instrument, or security out there, OTC options have their benefits and disadvantages.

Pros

The biggest and most obvious advantage to OTC options is that they’re tailored for specific parties. That means that the parties engaged in the options contract get precisely the terms that they want and a contract that fits with their specific goals.

Further, the OTC market allows for trading of both securities and derivatives (like options) for small companies (exotic options) that aren’t listed on the typical exchanges. That gives investors and traders more options.

Effectively, the OTC market, and OTC options, provide investors with more investment choices. That can increase the risk – but also the potential rewards – of such securities.

Cons

The drawbacks of OTC options concern the lack of standardization of contracts (which may be a con for some investors), and the illiquid nature of the market. Plus, that illiquidity can add additional costs. And, again, there’s no secondary market for OTC options.

The big thing investors should remember, too, is that there can be a lack of information and transparency in the OTC market. Many OTC stocks are hard to dig up reliable information on, which adds to their risk profiles. The same holds true for OTC derivatives.

While with standard options, you can find data and availability through your broker’s portal, such information can be harder to come by for OTC options.

The Takeaway

There are some benefits to trading OTC options, but it requires a thorough understanding of how the market works and the risks that it presents. That said, going over-the-counter can open up a whole new slate of potential investments.

Opting for an options trading platform that offers educational resources, like SoFi’s, can help you continue learning to improve your investing know-how. Plus, SoFi’s platform boasts an intuitive design which allows investors to trade options either from the mobile app or web platform.

Trade options with low fees through SoFi.

Photo credit: iStock/g-stockstudio

Jan

2022

What Are Binary Options? How to Trade Binary Options

What Is Binary Options Trading? How to Trade Binary Options

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

Binary options are a type of trading option in which investors either end up making up to $100 or they make nothing. Once the investor enters into the options contract, they don’t have to do anything else.

Below, we’ll give you the full rundown about binary options, including what they are, how they work, how to trade binary options, how to make money with binary options, and finally, why it’s so important to understand their ins and outs before making any moves.

What Are Binary Options?

A traditional binary option is a type of options contract, in which investors bet whether the price of the underlying stock will be above or the option’s strike price. In industry terms, they’re either “in the money,” or “out of the money.” Prices, of course, can be hard to predict, which is what makes binary options something of a gamble.

Here’s a fairly straightforward example: You think that the price of Stock X will be $10 or more on January 4, at 4 PM ET. You acquire a binary option contract with that stipulation — the other party on the contract holds the other position, that the price of Stock X, on the agreed upon time and day, will be less than $10.

When the clock strikes 4 pm ET on January 4, Stock X’s price is either $10, or it’s less than $10. Depending on what it is, one person is “victorious.” There’s no middle ground.

International traders may offer other variations of binary options as well.

How Binary Options Work

The inner workings of traditional binary options requires a baseline knowledge of their key elements. That includes a few things:

• The strike price. This is the price at which the option will execute, and when it comes to binary options, is the fulcrum point at which traders must choose a position — above, or below.

• The underlying asset, security, or market. This is the security (stock, commodity, etc.) upon which the options contract is based. Since options are derivatives, they’re tied to an underlying asset.

• The expiration date. The day and time when the contract executes.

• The expiration price. The price of the underlying asset when the contract executes.

These elements (along with a few other minor ones) comprise a basic binary options contract. Now, as far as how the option actually works, it’s pretty simple.

In effect, an options trader buys a binary option contract from another party who has taken the opposite position. That is, if you were to buy a contract with the position that the option’s underlying asset will exceed the strike price on the agreed expiration day and time, the other trader would have the equal and opposite position — they’re betting that the underlying asset’s value will not exceed the strike price when it expires.

When the clock does strike midnight, so to speak, on the expiration date, one of the two positions will have made the correct choice. The value of the underlying asset will either be above or below the strike price. The successful trader then receives a payout.

That payout is either $100, or nothing, regardless of how much higher or lower the value of the security is compared to the strike price. It’s like betting $100 on a World Cup match — your team either wins, in which you get your buddy’s $100, or your team loses, and you have to fork over $100.

Like all options, pricing on binary options reflects the time value of money, and their price, though always less than $100, will fluctuate depending on their current price and the length until expiration.

How Binary Options Trading Works

If you have any experience investing online, it should be pretty easy to get started. But before you do that, of course, you’ll want to make sure that you know what you’re getting into. That means doing some homework about how binary options work, the risks involved, and considering whether binary options trading jives with your overall strategy.

With all of that in mind, actually trading options contracts is almost as simple as trading stocks. You’ll want to find a binary options broker (which are usually specialized brokers such as
Nadex , Pocket Option , and BinaryCent ), open and fund an account, and from there, start executing trades.

Pros and Cons of Binary Options Trading

As with any type of investment or trade, binary options have pros and cons. Here’s a quick look at them:

Binary Options: Pros and Cons

Pros	Cons
Risks are capped	Rewards are capped
Fast and efficient	Highly speculative
Known payouts	Fraud Concerns

Pros of Binary Options

There are some positives to trading binary options.

• Limited risks. Traders can only lose so much if they end with the short straw.

• Efficient process. Binary options trading is usually a fast, efficient, and easy process, and they expire quickly.

• Known payouts. Since binary options are capped at $100, you know in advance what’s at stake. It’s always nice to know where things might land, right?

Cons of Binary Options

There are also some potential disadvantages to trading binary options.

• Limited gains. There’s only so much “winning” a trader can do with a given binary options contract.

• Speculative nature. You may get the feeling that you’re simply placing a bet at the roulette table when trading binary options, so prepare for that.

• Unregulated markets. Some brokerages and exchanges that offer binary options operate outside of the United States, and away from regulators. That could increase the risk of fraud.

3 Potential Binary Options Frauds to Watch For

The risk of fraud is a bit more pronounced in the binary options sphere because many platforms and brokerages that allow traders to trade binary options are unregulated. That means they’re not conducting business under the authority of the Securities and Exchange Commission (SEC) or other regulators.

It’s worth noting that if you trade with a well-regarded broker, your chances of getting scammed are probably pretty slim. Even so, here are a few types of fraud that you may run into when trading binary options.

1. Identity Theft

You’re likely familiar with identity theft, and some traders have lodged complaints with regulators that certain online trading platforms have been collecting personal data (credit card numbers, etc.) and then using it as they will.

How might this play out in the wild? Let’s say you want to do some binary options trading, and after a bit of Googling, find a platform that looks fun and easy to use. You sign up, fork over some personal information, and start trading.

A while later, you might get alerts that your credit has been compromised, or something similar. This could be a sign of identity theft, and it may all stem back to when you gave your personal information to that trading platform.

It’ll require some investigation to get to the culprit (if it’s even possible), but the point is that some sites play fast and loose with personal information. Or, they may not do a good job of securing it.

As a rule, it’s generally a good idea to keep your personal data to yourself, and not upload it to unfamiliar platforms.

2. Trade Manipulation

You can’t win if the game is rigged, right? This is another common complaint lodged against certain brokerages. Specifically, some traders say the exchanges manipulate the software used to execute trades to ensure the trader ends up on the wrong side of the trade.

In effect, this would be a case of the dealer taking a peek at the next card in the deck during a game of Blackjack, seeing that you’re going to hit “21,” and replacing the winning card with another.

3. Refusing to Credit Accounts

Another common complaint is that some platforms accept customer deposits, but then don’t allow them to withdraw the funds. Platforms may cancel withdrawal requests, or ignore them, leaving traders unable to access their money.

If this happens and the brokerage or platform you’ve been dealing with is in a foreign country (or its location is unknown), you might be out of luck. Again, stick to well-known brokerages or platforms, and you’re less likely to run into these types of issues.

Binary Option Fees

The fees for trading differ depending on the platform or brokerage you’re using, so that’s something to keep in mind when deciding where you want to execute trades.

Some platforms make money through commissions, and as such, will incorporate fees into contract spreads. Others simply charge a per-contract fee. Check your preferred platform or brokerage’s pricing guidelines to make sure you’re comfortable with any applicable fees.

The Takeaway

Whether you’re interested in trading binary options or stocks and bonds, it’s important to do your homework first. That means understanding a financial instrument, be it a binary option, or a vanilla stock, before you add it to your portfolio.

An options trading platform like SoFi’s can make it easier to understand what you’re getting into, thanks to its library of educational resources about options. The platform’s intuitive and approachable design allows you to trade options through the mobile app or the web platform, depending on what you prefer.

Trade options with low fees through SoFi.

Photo credit: iStock/dinachi

Jan

2022

What Are Simple Agreement Tokens (SAFT)?

By Brian Nibley | Growing Wealth, invest, Investing | Comments Off

When someone has an idea for starting a new business, they typically need startup funding. Unless they already have a lot of their own money, financing for a new entrepreneurial endeavor requires fundraising from somewhere.

Crypto-related startups looking to launch a token can finance their operations using a Simple Agreement for Future Tokens (SAFT). This fundraising method is an alternative to initial coin offerings (ICOs).

Simple Agreement for Future Tokens Explained

Simple agreement for future tokens (SAFT) are a type of fundraising targeted at accredited investors (those with a high net worth). Rather than offering new tokens immediately, as would happen in an ICO, a SAFT promises investors tokens in the future, after the project launches.

Why would aspiring entrepreneurs choose to raise funds in this manner? The reason has to do with crypto regulations.

Regulatory agencies in the U.S. like the Securities and Exchange Commission (SEC) and the Commodity Futures Trade Commision (CFTC) have called for the issuance of new tokens like ICOs to be treated as securities offerings. This would make the new cryptos and the companies behind them subject to the same regulations that shares of new stocks created in an initial public offering (IPO) might be.

The SAFT has been devised as a way to avoid this kind of regulatory scrutiny. Because new coins are not issued right away as they would be in an ICO, companies and investors participating in a SAFT technically are not participating in the issuance of new securities.

SAFTs have become popular with startups because it allows them to forego the process of registering their offering with the SEC. In fact, because the tokens are being sold to accredited investors, startups often don’t have to register the assets as securities at all.

The SAFT contract itself is considered a security. But at the time of agreement, no tokens are exchanged, so the tokens are, for the time being, not seen as securities.

If this were to change, then it could mean that companies creating SAFTs acted as unregistered broker-dealers. In that case, the contracts could be voided, and the SAFTs could be canceled.

Are SAFTs the Same as ICOs?

As mentioned, while both SAFTs and ICOs involve the issuing of new tokens, they are not the same.

ICOs offer coins upfront (often some kind of utility token). Investors exchange funds for the new tokens. In SAFTs, investors put up funds for the promise of receiving new tokens at a later date.

While both SAFTs and ICOs are methods of fundraising for new crypto startups, the difference lies in when the tokens are issued. SAFTs are also only available to accredited investors, while ICOs can be made available to anyone.

Who Can Invest in SAFTs?

SAFTs are only available to accredited investors, including legal entities such as trusts, limited liability companies; businesses like banks, investment broker-dealers, insurance companies, and pension or retirement plans; and individuals with certain FINRA licenses or with more than $200,000 in annual income ($300,000 if married) for at least the previous two years or a net worth of over $1 million. Such investors are sometimes permitted to participate in riskier ventures based on the assumption that they will be better able to weather the storm if their investment doesn’t work out.

How Does a SAFT Work?

A SAFT is a cryptocurrency investment contract between two parties. How it works: A blockchain startup agrees to launch a blockchain-based project that involves some kind of token. In exchange for funding right now, the startup enters into an agreement with investors to provide them with new tokens after launch.

Investors have to pay with money now (local fiat currency) and the company has to pay with tokens later.

Because SAFTs are investments in blockchain-based companies, it’s natural for the agreement itself to be hosted on the blockchain. Smart contracts are a preferred method of enforcing SAFTs, although they could technically be drafted and signed in other ways as well.

A SAFT might be considered even riskier than an ICO, because while an ICO offers an ICO token upfront, a SAFT offers only the promise of a future token distribution.

What Are the Pros & Cons of SAFTs?

SAFTs are high-risk investments that come with their own set of unique issues. Investors could make big profits or they could lose their entire investment quickly.

SAFT Pros

Here are some of the pros of investing in a SAFT.

• Speed and efficiency. The SAFT agreement can be created as a smart contract and executed automatically after both parties have signed. This eliminates the need for a lawyer to validate the agreement.

• Immutability. Blockchain-based transactions like those executed by smart contracts can’t be reversed.

• Potential for high returns. Some new alt coins see their value skyrocket shortly after launch. A few have even attained market caps in the billions after just a year or two. Early investors could potentially see huge profits if they get lucky and cash out at the correct time.

SAFT Cons

There are also some cons of investing in a SAFT.

• High risk. The cryptocurrency behind a given SAFT hasn’t even been invented and launched yet, so there’s no guarantee that it will have any value at all on the open market.

• Not all can invest. Only accredited investors may invest in a SAFT. That means unless they can meet the strict financial requirements, the average person won’t be able to participate.

• Regulatory uncertainty. Even though SAFTs are considered a type of security, it’s unclear whether or not the tokens themselves will be declared securities at some point later on. Add to this the vague legalities surrounding the contract itself, and it adds up to plenty of uncertainty in terms of what both parties can expect.

• Smart contract risk. Developers have to create smart contracts without exploitable bugs in order for them to work successfully and not get hacked. Many smart contract protocols have been hacked in the past, resulting in billions of dollars’ worth of losses for users.

SAFT Regulations to Know

In any discussion of SAFTs, ICOs, or new tokens in general, something that often comes up is the Howey test. This test is a set of criteria that the SEC applies to an investment to judge whether it qualifies as a security.

The Howey test refers to a Supreme Court case from 1946 entitled SEC v. W.J. Howey Co. In this case, the courts ruled that a certain kind of leaseback arrangement was a security that requires registration. The outcome of the case established several criteria that can be used to decide if an investment qualifies as a security.

If an investment meets these conditions, then it is classified as a security under the Howey test:

• An investment of money

• In a common enterprise

• With the expectation of profit

• To be derived from the efforts of others

The Takeaway

The SAFT definition is this: it’s a high-risk investment in the token of a blockchain startup that is only accessible to accredited investors. Most people won’t be able to participate in a SAFT. It’s a relatively recent development and it remains to be seen how many SAFTs will prove to be scams and how regulators will respond going forward.

Photo credit: iStock/ozgurcankaya

Jan

2022

Guide to Margin Trading Crypto

By Brian Nibley | Growing Wealth, invest, Investing | Comments Off

What if it were possible to trade crypto with more money than you actually have?

Margin trading in crypto involves just that. Similar to margin trading other securities, crypto traders can try to amplify their gains (or losses) by using borrowed money.

In crypto markets, margin trading has the potential to lead to unbelievable gains — or devastating losses. Novice traders would do well to exercise extreme caution when trading on margin.

In this guide, we’ll cover what margin trading is and how to margin trade crypto so you can decide if it’s right for you.

What Is Margin Trading Cryptocurrency?

Margin trading in crypto involves borrowing funds from an exchange and using it to make a trade. Margin trading is also referred to as trading with leverage because it involves traders “leveraging up” their trades beyond the existing capital they have to work with.

Margin Trading Cryptocurrency Example

Here’s an example: imagine that a trader opens a long position on Bitcoin for $100 and the price rises by 10%. The trader would make $10 in profit (excluding any fees).

If that same trader were to make the same trade using 5x leverage, their profit would be $50 (10 x 5 = 50).

Some investors who use margin trading in crypto use 10x, 50x, or even 100x leverage. This can amplify potential gains, but it also comes with much greater risk.

How Does Margin Trading Crypto Work?

Margin trading crypto involves borrowing money in order to make larger or more trades. But an important factor to keep in mind is what’s called the liquidation price. When the market reaches the liquidation price, the exchange will automically close a position. This is done so that traders only lose their own money and not the funds that were lent out to them.

When one is trading with only their own funds, the liquidation price for a long position on an asset is zero. But with increasing leverage, the liquidation price climbs closer to the price at which a trader buys.

Investors can use margin lending to establish either long or short positions (yes, it’s possible to short Bitcoin), allowing for the potential to profit no matter which way the market moves.

For example, say the price of one Bitcoin (BTC) is $10,000. A trader wants to do some Bitcoin margin trading and establishes a long position by buying one Bitcoin with 2x leverage. That means they would have spent $10,000 and borrowed an additional $10,000 for a position worth $20,000 before fees and interest.

In this case, the liquidation price would be slightly over $5,000. Once this level has been reached, the trader would lose their entire investment plus interest and fees.

Here’s why: buying $10,000 worth of BTC would normally require the price to drop to zero for a trader to lose their entire position. But with 2x leverage, the bet has been doubled. A trader has amplified their potential gains or losses by two times their initial investment. Therefore, if the price drops 50%, they wind up losing 100% of what they invested (50 x 2 = 100).

The exact liquidation price in this example would be a little higher than 50% less than the buy price because part of the cost to open the position includes fees and interest.

Liquidation Price Calculation

To calculate the size of a market move that will trigger a liquidation, simply divide 100 by the level of leverage. For example, a position with 10x leverage requires only a 10% move to be liquidated (100 / 10 = 10). A 10% move can happen within hours or even minutes in the crypto markets.

Where Can You Trade Crypto on Margin?

There are a number of crypto exchanges that allow traders to trade on margin, including:

• BitMEX

• Binance Futures

• Phemex

• Huobi Futures

• Bybit

• KuCoin Futures

• PrimeXBT

• ApolloX

• Delta Exchange

These exchanges offer leverage of anywhere from 10x to 125x. Trading with the use of leverage is risky in any market, and the more leverage used, the higher the risk. Margin trading in crypto markets is even riskier due to the extreme volatility.

What Are the Fees for Crypto Margin Trading?

There are two costs associated with margin trading crypto:

1. Fees for opening a position

2. Interest owed for borrowing coins

The interest rate, known as the “funding rate”, is peer-to-peer and depends on a variety of factors like the current premium between the spot and futures price of an asset. This rate is usually re-calculated each hour.

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 11%* and start margin trading.

*For full margin details, see terms.

Pros and Cons of Margin Trading Cryptocurrency

As with any investment strategy, there are positives and negatives associated with margin trading in crypto. This chart maps them out.

Pros	Cons
Potential for large profits in a short amount of time	Extremely high-risk — and any uptick in volatility increases risk even more
Allows traders to establish bigger positions with less capital	It’s possible for traders to lose large amounts of money very fast. During bouts of volatility, trades may be liquidated at a loss before traders can react
Can provide a way to make winning trades during small market moves	Requires near-perfect timing of the market
Allows traders to keep less crypto on an exchange	A trader has to exit a position when it’s profitable, as market moves become amplified with leverage. Inexperienced traders are likely to take large losses when trading with leverage.

Risk Management and Cryptocurrency Margin Trading

Trading on margin is very high-risk. The higher the volatility and the more leverage used, the greater the risk, as the chances of a trader being “blown out” of their position (when the liquidation price hits) increases.

This makes margin trading in crypto among the riskiest endeavors an investor could possibly pursue.

In an attempt to manage this risk, many traders hedge their bets by opening opposing positions. This is a common way of dealing with investment risk management.

For example, if someone holds a lot of Bitcoin, this would be considered a long position. One way to hedge against the downward price volatility might be to place a leveraged short position. This way, if the price of Bitcoin falls, the short position will rise in value and the investor may recoup some of their losses.

The Takeaway

Margin trading in crypto is often utilized by professional traders. The leverage involved can lead to exaggerated market moves known as “long squeezes” or “short squeezes,” where a sudden price movement can trigger liquidations and result in greater volatility. This happens often in the crypto markets, which trade very thinly compared to most traditional markets.

FAQ

Is crypto margin trading profitable?

When it works, margin trading in crypto can be very profitable. If a long position gets initiated right before a price surge, traders could make many times their initial investment. Of course, with cryptocurrency markets being very volatile, the opposite can just as easily happen. Large losses can be realized in short amounts of time.

Which coin is best for margin trading?

It depends on the individual. Someone looking to get into crypto margin trading with the least risk possible might consider Bitcoin to be the best coin because of its lower volatility when compared to other coins (note: that’s still a lot of volatility). Others might see smaller coins as being the best because they could potentially provide bigger returns on a shorter time frame, but the risks of steep losses are just as great.

Photo credit: iStock/Astarot

Jan

2022

Bitcoin IRA: Retirement Investing With Cryptocurrency

By Melanie Mannarino | Growing Wealth, invest, Investing | Comments Off

A Bitcoin IRA (individual retirement account) is a self-guided retirement account that holds Bitcoin in its portfolio. Typically, most IRAs invest in stocks, bonds, mutual funds, and ETFs. A Bitcoin IRA invests in Bitcoin, and perhaps several different types of cryptocurrency.

What is a Bitcoin IRA

The term “Bitcoin IRA” simply refers to an IRA that includes Bitcoin. There is no official designation for a Bitcoin IRA or Bitcoin Roth IRA by the IRS or any other regulatory agency.

How Does a Bitcoin IRA Work?

A cryptocurrency IRA works much like any other IRA. It’s a retirement account that invests in Bitcoin. The main difference for most customers is they will likely be interacting with three different entities:

1. Bitcoin IRA Service Providers: These are the companies an individual will deal with when they want to add Bitcoin to their IRA. They are the financial rails through which assets will be converted into Bitcoin.

2. Self-Directed IRA Custodians: These may be banks, trust companies, or any other entity approved by the Internal Revenue Service (IRS) to act as an IRA custodian. Traditional IRAs invest in stocks and bonds, but self-directed IRAs may allow alternative assets such as real estate, promissory notes, tax lien certificates, or cryptocurrency.

3. Custody or Wallet Providers: Typically, a Bitcoin IRA service will have a partnership established with a trusted wallet provider or custody solution that securely holds the private keys to a customer’s Bitcoin funds.

Can You Invest a 401(k) in Bitcoin?

The answer to this question is “maybe, but probably not.”

Until recently, 401(k) plans didn’t allow for the direct purchase of cryptocurrency. But some companies, like ForUsAll, BitWage, and Digital Asset Investment Management are starting to offer Bitcoin and other cryptocurrencies in 401(k) plans. Of course, since 401(k) plans are employer-sponsored, interested investors may be limited by what their particular company offers in terms of options. A self-employed individual seeking out a solo 401(k) may find they have more options.

There are other potential ways to roll over a portion of your 401(k) plan into Bitcoin, but the easiest way might be to use a traditional IRA.

Pros and Cons of Using a Bitcoin IRA

There are plus sides and down sides to including Bitcoin in your IRA planning. Here are some major points worth noting.

Pros of a Bitcoin IRA

A cryptocurrency IRA could provide some unique benefits, including offering overall portfolio diversification, and potentially large price appreciation.

Diversification

Bitcoin provides a unique way to diversify an individual’s overall investment portfolio.

Given Bitcoin’s performance it’s often said that Bitcoin is “uncorrelated” with the rest of the investment world. While that trend was upended in early 2020 as Bitcoin experienced a positive correlation with the S&P 500, some investors still consider it a more volatile investment.

Price Appreciation

Given that cryptocurrency is an uncorrelated asset class and exists outside the control of any single centralized authority, some investors have wondered if it could be a reasonable retirement option.

That said, past performance is never a guarantee of future returns. Bitcoin has also seen some big drops, most recently falling 12% in just 10 days from January 1 – January 10, 2022.

Cons of a Bitcoin IRA

There are also potential drawbacks to holding investments in a Bitcoin IRA, including both volatility and fees.

Volatility

Bitcoin has shown extreme volatility at times. This is one of the main reasons that cryptocurrencies are considered a risky investment.

While the list of large corporations (like PayPal, Square, and MicroStrategy) and self-made billionaires announcing large investments in Bitcoin continues to grow, volatility could be a big drawback for investors with low risk tolerance, as well as people who are close to retirement. Seeing investment funds fall by 10 or 20% (or more) in a single day can be too much for some people.

Fees

Perhaps the biggest and most assured drawback of investing in a Bitcoin IRA is the fees involved.

Aside from initial deposit minimums that are typically in the thousands, investors in Bitcoin IRAs can expect to pay fees including account setup fees, monthly platform fees, yearly administrative fees, transaction fees, and cold storage fees. Additionally, in some cases there are trade minimums, and there may be additional fees in excess of 1% per trade.

And as with other IRAs, withdrawing funds before retirement normally results in additional fees and taxes.

Taken together, the final taxes and fees could eat into a portion of the profits and tax advantages earned by a Bitcoin IRA.

How to Invest in a Bitcoin IRA

The main way to invest in a Bitcoin IRA is to use a trusted service provider that helps investors establish IRAs that hold Bitcoin.

There are some companies that have partnered with Bitcoin custodial services like BitGo, for example, to help safeguard funds for investors — although these companies cannot guarantee against loss. The specific process for starting a Bitcoin IRA might vary according to which provider an individual chooses.

A Bitcoin IRA provider can help investors buy cryptocurrency to add to their portfolio while also safeguarding the funds for them.

Is a Bitcoin IRA Account Safe?

The safety of a Bitcoin IRA account depends largely on how a Bitcoin IRA company stores the private keys to an investor’s crypto.

It is widely acknowledged that to be truly safe, keys must be held off-line in cold storage and secured using some kind of multi-signature (multi-sig for short) method. This ensures that the funds can’t be accessed by any hacker on the internet, and that multiple access methods are required to retrieve any funds.

Multi-sig works kind of like a safety deposit box, where there are two physical keys — one held by the bank and one held by the customer. There must be at least two means of user verification before funds can be accessed. A basic example would be a customer having to answer emails from two separate email accounts. More complicated methods might involve some kind of photo or voice identification in addition to multiple emails and an additional key held by the custodian of the funds.

Is Bitcoin Investing Safe?

There is no situation in which Bitcoin investing is “safe” — there is always a risk of loss with the current state of volatility in Bitcoin and cryptocurrency in general.

As far as investment gains or losses are concerned, investors will have to decide for themselves whether or not long-term Bitcoin investing falls within their comfort level and their goals.

That said, the prospect of incredible returns seems to sway more and more investors. Since 2009, the price of one Bitcoin in U.S. dollar terms has risen well over 1,000,000%, making Bitcoin the best performing asset of the decade — and in history.

While past performance is never a guarantee of future outcomes, if this trend were to continue, it could potentially mean substantial returns for investors over the long term.

Are Bitcoin IRAs Right for You?

As with any retirement planning, it’s important to take into consideration your time horizon (how many years it will be until you retire) as well as retirement goals, budget, and other personal factors. For individuals who feel comfortable with the general volatility of cryptocurrency in general, and Bitcoin in particular, a Bitcoin IRA might be one way to bring an additional layer of diversity to a retirement portfolio.

But for investors with low risk tolerance, a Bitcoin IRA is more financially risky than opening a traditional IRA composed of stocks and bonds.

The Takeaway

A Bitcoin IRA is an IRA that can hold a variety of assets like gold, real estate, or Bitcoin.

In recent years, several service providers have stepped in to fill the market need for people wanting to add Bitcoin to their retirement accounts.

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Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

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Stock Bits
Stock Bits is a brand name of the fractional trading program offered by SoFi Securities LLC. When making a fractional trade, you are granting SoFi Securities discretion to determine the time and price of the trade. Fractional trades will be executed in our next trading window, which may be several hours or days after placing an order. The execution price may be higher or lower than it was at the time the order was placed.
²Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2023. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.

First Trade Amount		Bonus Payout
Low	High	Bonus Payout
$50	$99.99	$10
$100	$499.99	$15
$500	$4,999.99	$50
$5,000+		$100

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