One of the primary reasons cryptocurrency has gained popularity among investors worldwide is its position as an emerging asset class with transformative potential. At the core of this innovation is blockchain technology, which many believe will revolutionize how financial transactions are conducted on a global scale.

For investors seeking long-term growth, cryptocurrency presents a compelling opportunity. The market is still relatively young, and many believe that the most established digital assets—such as Bitcoin and Ethereum—have significant upside as adoption increases. There’s a growing expectation that crypto will play a central role in the future of finance, both as a medium of exchange and a store of value.

Because of this growth potential, many investors are choosing to hold crypto in Self-Directed retirement accounts, particularly Roth IRAs, where gains can grow entirely tax-free. If you believe that the value of major cryptocurrencies will continue to rise over time, holding them in a Self-Directed Roth IRA allows you to lock in those future gains without owing taxes—as long as you’re over age 59½ and the account has been open for at least five years.

Bitcoin has become the leader in a wave of cryptocurrencies built on decentralized peer-to-peer networks and has become the primary standard for cryptocurrencies. The currencies inspired by Bitcoin are collectively called altcoins and have tried to present themselves as modified or improved versions of Bitcoin. While some of these currencies are easier to mine than Bitcoin, there are tradeoffs, including greater risk brought on by a degree of lesser liquidity, acceptance, and value retention.

Bitcoin holds a very simple data ledger file called a blockchain. Each blockchain is unique to each user and his/her Bitcoin wallet.

All Bitcoin transactions are logged and made available in a public ledger, helping ensure their authenticity and preventing fraud. This process helps to prevent transactions from being duplicated and people from copying bitcoins.

While every Bitcoin records the digital address of every wallet it touches, the Bitcoin system does NOT record the names of the individuals who own wallets. In practical terms, this means that every Bitcoin transaction is digitally confirmed but is completely anonymous at the same time. People cannot easily see your identity; however, they will be able to see the history of your Bitcoin wallet.

While Bitcoin is the most popular cryptocurrency, there are countless others like:

Even though Bitcoin is labeled as a “cryptocurrency”, from a federal income tax standpoint, Bitcoins and other cryptocurrencies are not considered a “currency.” On March 25, 2014, the IRS issued Notice 2014-21, which for the first time set forth the IRS’s position on the taxation of virtual currencies, such as Bitcoins. According to the IRS Notice, “Virtual currency is treated as property for U.S. federal tax purposes.” The Notice further stated, “General tax principles that apply to property transactions apply to transactions using virtual currency.”

In other words, the IRS is treating the income or gains from the sale of a virtual currency, such as Bitcoins, as a capital asset, subject to either short-term (ordinary income tax rates) or long-term capital gains tax rates, if the asset is held greater than twelve months (15% or 20% tax rates based on income). By treating Bitcoins and other virtual currencies as property and not currency, the IRS is imposing extensive record-keeping rules – and significant taxes – on their use.

Related: Can I hold my Private Keys in a Crypto IRA?

Each year, your alternative asset custodian is required to report the fair market value (FMV) of the assets held in your retirement account. For alternative investments, this typically means getting a third-party valuation or providing a qualified estimate. Proper documentation ensures IRS compliance and keeps your account in good standing.

The Internal Revenue Code does not describe what a Self-Directed IRA can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibit Disqualified Persons from engaging in certain types of transactions. The foundation of the prohibited transaction rules is based on the premise that investments involving IRA and related parties are handled in a way that benefits the retirement account and not the IRA owner. The rules prohibit transactions between the IRA and certain individuals known as “disqualified persons”.

The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest.

Because the IRS treats cryptocurrencies, such as Bitcoins, as a capital asset, such as stocks or real estate, a retirement account is permitted to buy, sell, or hold cryptocurrencies in their retirement subject to the prohibited transaction rules found under Internal Revenue Code Section 4975(c).

The advantage of using retirement funds to invest in cryptocurrencies is that, in general, all the income and gains generated by the investment would not be subject to any tax or penalty. Instead of paying tax on the returns associated with the cryptocurrency investment, tax is paid at a later date, leaving the investment to grow unhindered. Using a self-directed IRA to make cryptocurrency investments is tax advantageous because the tax on the interest payments can be deferred in the case of a pre-tax IRA or exempted permanently in the case of a Roth IRA.

Unfortunately, none of the major financial institutions will allow you to use IRA or 401(k) plan funds to invest in cryptocurrencies or essentially anything outside of Wall Street. The reason for this is simple: banks do not make money when you invest in non-traditional equities, such as private equity or venture capital investments. They make money when you buy stock, mutual funds, and other financial products they market. As a result, a large number of individuals are turning to a Self-Directed IRA to invest in bitcoin and other cryptocurrencies.