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Crypto Plunge a Wake-Up Call — and Tax Opportunity — for Investors

Janos Kummer | Getty Images News | Getty Images
  • The price of cryptocurrencies like bitcoin and ethereum cratered Friday after China essentially declared the digital currencies illegal.
  • Investors shouldn't necessarily run for the hills. But the price swings are a reminder of the asset's characteristic volatility.
  • Investors may be able to yield a tax benefit from the crypto price plunge.

The price of popular cryptocurrencies like bitcoin and ethereum plunged Friday after Chinese officials intensified a crackdown, essentially declaring crypto to be illegal.

The government intervention, while significant, doesn't necessarily mean investors should run for the hills, though, according to financial advisors. But it's another reminder that crypto holdings are subject to wild price swings, they said.

"I wouldn't call this the end of the world," said Leon LaBrecque, an accountant and certified financial planner at Akron, Ohio-based Sequoia Financial Group. "It's just a wake-up call."

"This ought to be a recognition that it's a volatile asset and all the ups and downs go together," he said.

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That volatility opens tax-planning opportunities that may be available for just a few more months, advisors said, depending on Democrats' ultimate compromise on federal tax legislation.

Bitcoin prices had fallen 6% to about $42,000 as of 3 p.m. ET Friday afternoon. Ether, the second-largest digital currency, fell more than 8% to roughly $2,890.

The People's Bank of China spooked investors after declaring all crypto-related activities illegal. Those activities include trading services and overseas exchanges, for example. It's the latest move in the country's broader crackdown on digital currencies.

Banning bitcoin and other cryptocurrencies may be worrisome for current and would-be investors, since the government is limiting the pool of buyers from a significant portion of the world population, advisors said. And other governments will likely impose additional regulations, too, they said.

But those may not make much difference for long-term prices. A day-to-day plunge in crypto's cost, which may feel significant at the time, is likely just part of a longer-term course correction toward some average price, advisors said.

"Is government regulation going to cause major fluctuations in crypto? Yes," said Wayne Wilbanks, managing principal and chief investment officer at Wilbanks Smith & Thomas Asset Management in Norfolk, Virginia. "Will it make crypto obsolete? No.

"I don't think China's regulation, or even U.S. regulations, make that much difference in the long-term," he added.

Bitcoin, for example, is still up roughly 40% on the year despite Friday's tumble. (It's well off its April high around $63,000, though.)

Volatility has been a signature of cryptocurrencies to date. This year, prices have swung wildly after tweets from Tesla co-founder and crypto enthusiast Elon Musk, for example.

Advisors typically recommend investors allocate a small amount of their portfolio (anything they'd be OK losing entirely) due to the risk.

Tax benefit

Investors can use recent volatility in their favor, according to Jeffrey Levine, CFP, accountant and chief planning officer at Buckingham Wealth Partners in Long Island, New York.

Stock, crypto and other investors are able to "harvest" investment losses for a tax benefit. Basically, they can sell a losing investment (bitcoin, for example) and use the loss to wipe out the gain of a winning investment elsewhere in their portfolio.

This "tax-loss harvesting" reduces (or erases) capital-gains tax, which is owed on the appreciated value of an investment that's sold.

However, unlike stock investors, crypto investors who sell out can quickly buy back into the same or a similar digital currency. Consequently, they can get the aforementioned tax benefit, as well as a portfolio benefit if the volatile asset rebounds in price shortly thereafter.

House Democrats proposed closing this crypto loophole after this year, as part of a push to reform the tax code.

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