The Impact of Fees and Taxes on Crypto Investment Performance
|Disclaimer: The following post is purely educational in nature and not legal advice (the post is not written by a tax professional). You should consult your own tax, legal and accounting advisors before engaging in any transaction.|
In 2021, the number of people considering investing in cryptocurrencies was higher than ever, as digital forms of money were, without question, entering the mainstream consciousness, blowing up to popularity heights previously unseen in this sector. Despite most regular folk not entirely understanding how the crypto world functions, many were still quick to pour money into this landscape, fearing they may pass up on the best investment opportunity of the century. Today, regardless of the massive dips in prices that most virtual money forms experienced in 2022, Triple A predicts that around 420 million people across the planet hold cryptos, putting the global cryptocurrency ownership rate at approximately 4.2%.
Yes, per a mid-2022 Pew Research Center survey, 46% of participants reported that their coin-based investments did not pan out as planned and are doing worse than expected. Experts also predicted that in 2023, Bitcoin’s investing outlook would drop by 60%. But, many remain unfazed by such projections and insiders’ opinions, staying true to the belief that blockchain technology and digital assets are our unavoidable future.
For those considering putting their fiat funds into the crypto sphere, buying coins, or gaining equity in companies aiming for success in the blockchain-powered industry, one thing to note is factoring in fees when measuring investment returns. Nothing in capitalism is free, and the same goes for participation in open markets, as those supplying any kind of services want their cut for doing so. The subheadings that follow provide a quick rundown of the trading fees associated with crypto investing, some of which also apply to the stock and forex markets.
Individuals who feel uncomfortable participating in the stock/crypto/forex markets by themselves opt to pay professional traders to manage their portfolios, meaning invest and actively trade their money. In such cases, portfolio managers make transactions and trades on a client’s behalf for a fee naturally. That is a popular practice, especially in the forex field, where rarely a few single investors are also experts in foreign currencies. Hence, those with such unique skills have a reputation for charging super high fees, usually between 20% to 30% of their traders’ earnings. Another reason for their steepness is that forex accounts are almost always high-risk/high-reward. So, it takes some extensive knowledge to minimize dangers and turn a profit in this landscape.
For comparison, stock management fees usually fall between 0.2% and 2%, depending on the size of the investments and the management style implemented. Note that these charges also get referred to as advisory or investment ones. It is worth mentioning that those who invest a large sum, or rank as high-net-worth people, usually receive lower management fees. But the typical one that gets taken is a percentage of the total assets under management. On top of these, the investor also often pays other costs, like those concerning legal services, taxes, valuation, accounting, and various operating expenses. These factor into something called the management expense ratio, or MER. Thus, it is vital that everyone consider the MER in its entirety when making investment choices.
Crypto hedge funds charge similar management fees to those who run other people’s securities portfolios. That means they rake in somewhere between 1% to 3% of client earnings, but almost always, they also have a performance pay table that ensures that if investments generate sizable returns, they get a piece of that pie. Also, all investment newbies who want to join such crypto hedge funds should know that not everyone can join high-end ones. As a rule of thumb, it requires a minimum stake, which can be as low as $100,000 or, as in the case of the Pantera Fund, a cool million.
When someone makes money, the taxman comes calling. There is no escaping that. Concerning investing, those who put their money to work must be aware that the government not only taxes income directly obtained through these processes, but it also wants sections of accumulated interests, paid-out dividends, and realized capital gains, which are profits accrued when one sells a stock or bond. The rate linked with long-term gains is 20%, 15%, or 0%, depending on the filing status and taxable income, interest income gets treated as an ordinary influx of funds, and on qualified dividends, shareholders pay a preferential tax rate of 20% in the US. Therefore, it is always vital for investors to account for taxes when assessing the state of their portfolio’s performance.
The Internal Revenue Service, famously known under the acronym IRS, per its regulations at the time of writing, chooses to tax virtual assets like investments and property due to the lack of laws regulating cryptos in the United States. They do not tax coins as fiat money. It is paramount that everyone remembers this, as that means that all profits attained through crypto-trading get subjected to capital gains taxes. For the 2022-23 filing season, crypto gains held for less than a year get a 10% to 37% tax applied depending on the taxpayer’s federal income bracket.
Mining and receiving cryptos as payments can too get taxed at income rates based on the value on the day the coins get transferred.
The number of trades executed in a specific interval gets called the trading frequency. When someone gets into high-frequency trading, that refers to using advanced computers and software that can perform a massive amount of trades in fractions of a second, thanks to the help of complicated algorithms that scan multiple markets and conduct transfers based on pre-set orders guided by market conditions.
Low-frequency trading is the opposite. It is a strategy that the majority of casual investors utilize. It entails executing very few trades taken over a monthly cycle. It requires a lower workload, increases the chances of trading with a trend, and boosts the reward-to-risk ratio on every transaction.
If someone has dedication towards crypto trading and exceptional knowledge of this sphere, one of the primary things that will stop them from raking in impressive earnings from this field is transaction fees. As every coin holder knows, when a blockchain transaction gets performed. The network where the transfers happen collects a fee. That is an amount charged for the transaction to get processed, meaning for adding data on the blockchain and for the computational effort needed to finalize it. It then gets handed off as a reward to those who maintain it. The size of these fees depends on the sum sent. It is a percentage of the transfer. Bitcoin’s average hovered around the $25 mark in the past, and the same applied to Ethereum, the second-most established blockchain.
That said, nice altcoins like Nano exist that facilitate fee-free cryptocurrency transactions. Unfortunately, they are not very popular. Well-known coins with low fees that are making waves are Ripple Bitcoin SV and Bitcoin Cash. So, picking the coins one will trade and how often one will buy/sell them directly impacts a crypto investment portfolio's bottom line.
Timing of Purchases & Sales
The timing of a purchase is the moment in time when an order gets placed, and the timing of the sale is the instance when a transaction gets finalized. In other words, when the subject of the trade changes hands from seller to buyer. In the investment realm, these terms also get interchangeably used for entry and exit positions.
Like with the stock market, the crypto one can be super volatile. In truth, most cryptos are far more susceptible to drastic price fluctuations in the short term than any securities. At least, that is what 2022 showed us when the price of Bitcoin fell from over $60,000 per unit to less than $20,000 for 1 BTC. While some stocks have experienced comparable drops, on average, their value shifts are not nearly as substantial as those most coins suffer, nor are they as frequent.
Yet, it is essential that everyone learns that cryptocurrencies are volatile by design. No uniform/universal regulator regime exists for their trading, making them highly speculative, trading at extra unpredictable rates. In one day, in 2021, the value of Bitcoin dropped 30%, which is something that is unfathomable for a fiat currency, except in conditions where a war of sizable proportions breaks up in a region or within a nation's borders. That means timing proper entry and exit points are of the utmost importance when trading cryptos. Moreover, what is also of consequence is the potential for future modification to blockchain fees, taxes, and management costs, as these can greatly affect the bottom line of a crypto investment portfolio as well.
When crafting an investment portfolio, most individuals analyze its health by implementing tools like the Sharpe ratio, a widely used method for measuring risk-adjusted relative returns. Nonetheless, many sadly neglect to account for the fees/taxes that must get paid during or after active trading to their detriment. These may seem minuscule within short time frames. In spite of that, they undoubtedly will pile on and quickly take a decently-sized chunk of an investor’s earnings. That is why it is necessary to factor in any predictable changes when investing, not forgetting them when judging where a portfolio stands and knowing what planned moves will incur what charges. That is a must for success in any asset trading form.