Crypto downturn is 'a wake up call' for investors, says CEO: How to reassess your portfolio

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Key Points
  • Bitcoin is trading below $30,000 per token, down from a high of nearly $68,000 in November 2021.
  • Sales of cryptocurrency are currently not subject to "wash sale" rules, meaning you can realize capital losses and immediately repurchase coins you own.

If you think stock returns have been rough of late, take a peek at the crypto market. Fair warning: You may want to look through your fingers.

Bitcoin, the largest cryptocurrency by market cap is currently trading below $30,000 per token, down from a high of nearly $68,000 in November 2021. Ether, the cryptocurrency associated with the ethereum blockchain (where all those NFTs live) has shed 59% of its value since November. And those are just some of the more prominent coins.

Investors in Luna, a digital currency tied to so-called "stablecoin" Terra, recently saw the coin's total market value plummet to $2,391 from a valuation of $1.6 billion in April.

The broad downturn in the crypto market means that if you're a newish investor in digital currencies, you're likely seeing big red numbers at the moment. If those losses have put a major dent in your finances, it could be time to reassess your strategy.

"I think it's a wake-up call. Hopefully you didn't lose your whole life savings," says Stéphane Ouellette, CEO of FRNT, a crypto-focused institutional capital markets platform. "A lot of people got sucked into stuff, and they didn't understand what they were buying."

Reassess your reasons for owning crypto, other investments

Any time you've seen a major decline in your portfolio, it's worth assessing whether those investments are still serving the purpose you bought them for. Some crypto proponents, for instance, bought their digital currency to serve as a non-correlated asset — one that they expected would be propelled by different market forces than more traditional investments, such as stocks and bonds.

Indeed, owning a portfolio of assets that move in different ways can help smooth your portfolio's returns over time. But thus far, prominent cryptocurrencies have moved very similarly to stocks.

"Everything suggests so far that cryptocurrencies are highly correlated with the broader market. When things go up, they will go up a lot more. When things slow down, they will go down a lot more," Tendayi Kapfidze, chief economist at U.S. Bank, told Grow.

That may not always be the case, points out Ouellette. "It's a very new market. When was the stock market popularized, 1880? By 1890 do you think they knew what correlations were?" he says. "Correlation is ultimately a bunch of people thinking the same way about something. There are so many opinions about what [crypto will be] useful for. You can't be certain about any correlations."

Depending on when you bought your crypto, you may also be disappointed with its success as an inflation hedge, as prominent coins have sunk in value of late as prices for goods and services have ramped up.

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Still, says Ouellette, even after the recent selloff, "bitcoin is at around $30,000. It was at $7,000 at the beginning of the pandemic, and it's almost twice as high as it was when it was first thought of as an inflation hedge."

In other words, it's too early to tell how digital currency markets will behave on a consistent basis over long periods. For now, it's reasonable to expect short-term volatility in any digital currency you own, experts say.

The coins you'd be wise to keep in your portfolio aren't the ones that you think will go up the most in the short-term, but rather those which have a long-term use case you believe in, says Ouellette. "If you were a casual crypto investor trying to make money by trading on momentum, go back to basics," he says.

Look over your crypto allocation

For crypto investors, part of going back to basics means understanding that crypto markets require a different approach than stocks. When stocks decline, the established thinking goes, it's wise for investors to consistently buy into a broad swath of market. That's because, as a whole, the stock market has historically trended upward.

To even be included in the stock market, a company has to go public, which means it's achieved a certain level of success and stability that doesn't have to be there to launch a new digital coin, says Ouelette. "The stock market is higher level of criteria. You can value companies on cash flows, profits, and growth trajectory, and once the market gets its mind right, it's going to be a success," he says. "You totally can't take that approach with crypto."

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Even if you buy a diversified swath of the digital currency market, you'll have to be comfortable with the possibility that a portion of those investments could go to zero. And if crypto prices rise again, the market could look completely different. "Think of the crypto darlings of 2017," says Ouellette. "You've never heard of them."

Be selective about which coins you own, and be careful about how much of your portfolio they occupy, experts say. When it comes to how much of your portfolio belongs in crypto, says Ouellette. "How much would you put into sports betting? How much would you bring to Vegas?"

Consider selling crypto … and maybe buying again

If you examine your portfolio and determine you want to hang on to some of your beaten-down crypto, it may nevertheless make sense for you to sell it as part of a strategy known as tax-loss harvesting.

As is the case with other types of investments, if you sell your crypto for less than you paid for it, you can realize a capital loss, which you can use at tax time to offset any capital gains. If your losses exceed your gains in a particular tax year, you pay no capital gains tax and can deduct up to $3,000 worth of losses from your regular income. Losses in excess of $3,000 can be carried forward into future tax years.

But where the rules around loss harvesting can get tricky for stocks and bonds, they're very straightforward for crypto, thanks to how it's taxed.

"The IRS treats cryptocurrency as property. Think of it like real estate," says Bill Smith, national director of tax technical services at CBIZ MHM's national tax office. "That means crypto isn't currently subject to the wash-sale rule, which applies to stocks, bonds, and options."

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The wash-sale rule negates a capital loss, for tax purposes, if you buy back an investment "substantially identical" to the one you sold within 30 days of selling it. (If you sold an S&P 500 ETF, for instance, you couldn't buy the same or any other S&P 500 ETF for a month without triggering the rule.) Because no such stipulation exists for crypto, you can sell your coins at a loss and repurchase your exact same portfolio without running afoul of IRS rules.

That may not always be the case, says Smith. "The Biden administration is hoping to install a wash-sale rule," he says. "Right now there is little chance of tax rule changes going through, but anything can happen."

For the time being, any losses you realize from selling your crypto at a loss, whether you buy back in or not, can be carried forward indefinitely and used to offset future gains. As with any tricky tax move, you'd be wise to consult with a professional before making any changes to your portfolio.

The views expressed are generalized and may not be appropriate for all investors. The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses.

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