The hiking interest, adoption, and cryptocurrency investment, also known as crypto, has increased the curiosity of numerous investors eager to enter the market. In this guide, cryptocurrency will be viewed as an asset class and elucidate the fundamentals of investing in it. Discover the essence of crypto, its various forms, factors to weigh before investing, and insights to help you ascertain if it merits inclusion in your portfolio. Should you decide to venture into a crypto investment, a step-by-step guide to embarking on this journey is provided.
What is Cryptocurrency?
Cryptocurrency, in essence, is a digital currency that exists and is transacted online. In practice, it functions as a digital asset with the potential for value appreciation or depreciation, just like stocks and bonds.
While traditional currencies comprise paper bills and metal coins, cryptocurrencies employ virtual “coins,” “tokens,” or “units.” These can be acquired from companies that enable cryptocurrency exchanges, allowing you to trade, purchase, or sell with other crypto holders, much like stock trading in the corporate world.
Cryptocurrency’s distinguishing feature from standard currency (apart from its intangible nature) is its decentralization. No central authority presides over the currency.
Bitcoin reigns supreme as the largest and most renowned cryptocurrency globally. Some financial experts even classify non-Bitcoin cryptocurrencies as “altcoins,” underscoring Bitcoin’s dominance.
What You Need to Invest into Cryptocurrency
Although the concept of cryptocurrency may seem intimidating to novice investors, the requirements for entry are minimal. To learn how to invest in cryptocurrency, you simply need:
- Personal identification documents
- Bank account information
- Secure internet connection
Alternatively, you can purchase cryptocurrency through a stockbroker, in which case most of your personal and financial data will already be on record. With these essentials in place, you’re ready to begin investing.
Considerations Before Investing Into Cryptocurrency
Before delving into cryptocurrency investment, acquaint yourself with these crucial points:
1. Capital Gains Tax
Cryptocurrency is deemed an asset for tax purposes, just like stocks or real estate. Profits from selling crypto are subject to capital gains tax. Bear this in mind when budgeting and planning for taxes.
2. Short-Term Investing
Cryptocurrency’s volatile nature leads many investors to view it as a short-term investment rather than a long-term one. In the future, cryptocurrency may stabilize and become a lucrative long-term investment, but that remains uncertain.
Given the fluctuating values of cryptocurrencies, attempting to time the market could yield higher profits, albeit with considerable risk. For long-term appreciation, consider investing in bonds, index funds, or IRAs instead.
Steps to Investing Into Cryptocurrency
As you contemplate diving into the world of cryptocurrency investments, it is crucial to have a solid financial foundation. This entails establishing an emergency fund, maintaining a manageable debt level, and ideally, cultivating a diversified investment portfolio. Cryptocurrency can serve as an additional component of your portfolio, potentially enhancing your overall returns.
To successfully invest in cryptocurrencies, consider these five essential aspects:
1. Know & Understand Your Investment
Just as with any investment, it is vital to comprehend the nature of the asset you are investing in. When purchasing stocks, investors typically scrutinize annual reports and SEC filings to thoroughly analyze companies. Adopt a similar approach with cryptocurrencies, as there are thousands of them, each with unique functionalities and new ones emerging daily. It is crucial to understand the investment rationale for each trade.
Many cryptocurrencies, such as Bitcoin, are not backed by tangible assets or cash flow. Investors rely solely on the prospect of others paying more for the asset than they did. Unlike stocks, where a company’s growth in profits can generate returns, many crypto assets depend on an increasingly optimistic and bullish market for profitability.
Popular coins include Ethereum, Dogecoin, Cardano, and XRP. Before investing, evaluate the potential risks and rewards. If your financial investment lacks asset or cash flow backing, it could ultimately be rendered worthless.
2. Focus on the Future, Not the Past
A common pitfall for novice investors is to dwell on past performance and assume it will continue. While Bitcoin’s value has skyrocketed from mere pennies, the critical question is whether this growth will persist, albeit at a potentially slower pace.
Investors should concentrate on future prospects rather than past achievements. What factors will drive future returns? To profit from a cryptocurrency, traders purchasing it today require gains in the future, not those of the past.
3. Be Mindful of Volatility
Cryptocurrency prices exhibit extreme volatility, with values capable of dropping within seconds based on unsubstantiated rumors. While this may be advantageous for seasoned investors with rapid trading capabilities and a firm understanding of market fundamentals, trends, and potential trajectories, it poses a significant risk for inexperienced investors.
Volatility is a playground for high-powered Wall Street traders, each vying to outperform their well-funded counterparts. Novice investors can easily be overwhelmed by such fluctuations.
Volatility can cause inexperienced traders to panic, while more seasoned investors may seize the opportunity to buy at a lower price. In essence, volatility enables sophisticated traders to “buy low and sell high,” while novice investors may inadvertently “buy high and sell low.”
4. Master Risk Management
When engaging in short-term trading of any asset, particularly volatile ones like cryptocurrencies, risk management is crucial. As a novice trader, it’s essential to develop a risk management strategy tailored to your individual needs and adhere to it diligently:
- For long-term investors, risk management might involve holding onto their assets regardless of market fluctuations. This approach allows them to maintain their positions with a long-term perspective.
- On the other hand, short-term traders may establish stringent selling rules, such as liquidating an investment after a 10% decline. Adhering to these rules helps prevent minor losses from escalating into devastating financial setbacks.
New traders should consider allocating a specific amount of capital for trading and initially using only a portion of it. This way, if a position turns unfavorable, they still have reserve funds to continue trading. Remember, maintaining a reserve ensures you always have the means to trade.
Managing risk is vital, but it can be emotionally taxing. Accepting a loss by selling a declining position may be painful, but it can prevent more significant losses down the line.
5. Don’t Invest More Than You Can Afford to Lose
It’s crucial not to invest essential funds in speculative assets like cryptocurrencies or other high-risk investments. If losing the entire sum would cause financial hardship, it’s unwise to allocate it to risky ventures.
Funds earmarked for significant purchases or short-term needs should be kept in secure accounts to ensure their availability when required. If you’re seeking a guaranteed return, consider paying off debt, as the interest saved is a surefire gain.
Additionally, don’t overlook the security of your chosen exchange or broker. While you may legally own the assets, their security must be robust. Some traders opt for a crypto wallet to store their coins offline, safeguarding them from potential cyber threats.
Alternative Cryptocurrency Investment Methods
Direct cryptocurrency investment is the most common approach, but traders have other options for entering the crypto market, each with varying degrees of risk and exposure:
1. Crypto Futures
These instruments allow traders to speculate on cryptocurrency price movements using leverage, potentially yielding substantial returns (or losses). However, futures markets can amplify the inherent volatility of cryptocurrencies.
2. Crypto Funds
Some funds, such as the Grayscale Bitcoin Trust, enable investors to bet on the price fluctuations of Bitcoin, Ethereum, and select altcoins through a fund-like product.
3. Crypto Exchange or Broker Stocks
Investing in companies like Coinbase or Robinhood, which generate significant revenue from crypto trading, can offer exposure to the broader cryptocurrency market without directly owning the assets.
4. Blockchain ETFs
These blockchain exchange-traded funds provide exposure to companies poised to benefit from blockchain technology. However, it’s important to note that these companies often have diverse business interests, diluting your direct exposure to cryptocurrencies and limiting both potential gains and losses.
Understanding the nuances of each method is crucial to determining whether it aligns with your investment goals and risk tolerance.
Top 3 Cryptocurrencies for Novice Investors
As a budding investor in the realm of cryptocurrencies, it is crucial to familiarize yourself with the diverse landscape of digital assets. With Bitcoin being the pioneering cryptocurrency, boasting a market capitalization of approximately $128 billion, it has paved the way for numerous other digital currencies.
Here, we delve into three of the most promising cryptocurrencies for those new to the investment game:
1. Bitcoin
As the quintessential digital currency, Bitcoin is an ideal starting point for beginners. Supported by every major currency exchange, Bitcoin serves as a digital cash alternative, facilitating currency and value exchange without intermediaries.
2. Ethereum
While Ethereum is a cryptocurrency, its primary focus lies in enabling the purchase of applications without the need for middlemen, such as the Apple Store. This unique selling point sets it apart from other digital currencies.
3. Cardano
As a competitor to Ethereum, Cardano is a cryptocurrency designed for storing private data. Its energy-efficient nature renders it a more cost-effective option, making it an attractive investment choice.
Choosing the Right Cryptocurrency for Investment
It is all too easy to follow the crowd when it comes to investing, but conducting thorough research is paramount. Cryptocurrencies hold no intrinsic value; rather, they represent ownership of a digital asset. Their prices are determined by public perception, so it is important to have confidence in the value of the cryptocurrency you choose to invest in. To develop this conviction, study white papers and gain a comprehensive understanding of which cryptocurrencies have the potential to appreciate in value before making any investment decisions.
Is Crypto a Good Investment?
Cryptocurrency investments inherently carry a degree of risk. As a general rule, high-risk investments should constitute a small portion of your overall portfolio, with a recommended maximum of 10%. Prioritizing retirement savings, debt repayment, or investing in less volatile funds comprising stocks and bonds may be more prudent.
To mitigate risk within your crypto portfolio, consider diversifying your investments across a range of cryptocurrencies. As digital assets may fluctuate at varying rates and timeframes, diversification can provide a degree of protection against losses in individual holdings.
Conducting due diligence is of utmost importance when investing in any asset, particularly cryptocurrencies, which are often associated with specific technological products in development or deployment. With looser regulations in the U.S., determining the viability of projects can be challenging. Consulting a financial advisor with cryptocurrency expertise may prove invaluable.
For novice investors, examining the adoption rate of a cryptocurrency is also beneficial. Most reputable crypto projects offer publicly accessible metrics, such as transaction volumes on their platforms. If a cryptocurrency’s usage is on the rise, it may indicate that it is gaining traction in the market. Additionally, scrutinizing white papers can provide insights into the workings of a cryptocurrency and its token distribution plans.
The Pros and Cons of Investing into Cryptocurrency
As the world of digital assets continues to evolve, many investors are considering the potential benefits and drawbacks of investing Into cryptocurrency.
Pros of Investing Into Cryptocurrency
- Diversification: Before 2022, cryptocurrencies exhibited a low correlation with traditional asset classes like stocks and bonds. This characteristic allowed investors to potentially improve their risk-adjusted returns by adding a small exposure to this high-growth space. Although correlations increased in 2022, it remains uncertain whether this trend will persist.
- Store of Value: Some experts liken cryptocurrencies, such as Bitcoin, to gold due to their fungibility, durability, and scarcity. Both assets have a finite supply and are not governed by a central authority, making them attractive as alternative stores of value.
- Security and Transparency: The decentralized nature and distributed ledger technology behind cryptocurrencies make it difficult to compromise network integrity, offering a secure and transparent investment option.
Cons of Investing Into Cryptocurrency
- High Volatility: The cryptocurrency market is notoriously volatile, with unpredictable price fluctuations and unclear drivers behind significant value swings.
- Security Risks: While blockchain technology is difficult to hack, individual investors can still fall victim to cyberattacks due to inherent risks associated with online activities.
- Limited Regulation: Cryptocurrencies are not heavily regulated, meaning transactions lack legal protection compared to traditional investments like stocks.
Securing Your Cryptocurrency Investment
To safeguard your crypto assets, consider the following tips:
- Choose reputable exchanges and digital wallet providers.
- Implement strong passwords, two-factor authentication, and secure internet connections.
- Stay vigilant against phishing scams targeting crypto users.
- Never share your password or private key with anyone.
FAQs
What should I know before buying cryptocurrency?
Cryptocurrency investments carry inherent risks due to their volatility, limited regulation, and uncertain future. Approach this asset class with caution and conduct thorough research before diving in.
What should I look for in a cryptocurrency investment?
Each cryptocurrency is unique, so the ideal choice depends on your circumstances. Beginners may want to explore established currencies with ample information on their functionality and historical performance.
How much should I invest in cryptocurrency as a beginner?
Only invest what you can afford to lose. It’s however recommended to allocate no more than 10% of your overall portfolio to any single crypto to mitigate crypto-specific risks.
