On January 3, 2009 the world changed. A new technology was introduced by a mysterious character named Satoshi Nakamoto. He called this new technology Bitcoin, which is the world’s first cryptocurrency. It was intended to be used as a “peer-to-peer electronic cash system”. Of course when the white paper released, everyone ignored it.
However, smart developers started noticing Bitcoin over time. They understood the implications this technology has for the future of currency and other applications. What was revolutionary is that this new network solved the double spend problem. Double spending is an issue with digital currencies since digital information can be reproduced. This ability to easily reproduce digital information is no longer the case with digital currencies such as Bitcoin. In this article, we’ll explore everything you need to know about investing in cryptocurrencies.
- What are cryptocurrencies?
- How investing in cryptocurrencies works
- How to buy or sell cryptocurrencies
- Ways to invest in cryptocurrencies
- How to earn from cryptocurrency investments
- What are the fees for cryptocurrency transactions
- Pros and cons of cryptocurrency investments
What are cryptocurrencies?
A cryptocurrency is a peer-to-peer network that is used as a form of digital money or other application that is designed to be secure. Many cryptocurrencies are global, anonymous, trustless, decentralized and censorship resistant. They rely on encryption techniques called cryptography. This is used to control the formation of additional units, secure transactions, and validate asset transfers. Cryptography converts legible information into code that is essentially impossible to hack. This security feature makes most cryptocurrencies impossible to counterfeit.
Let’s discuss what it means for a cryptocurrency to be decentralized. As opposed to centralized conventional currencies, cryptocurrencies use decentralized peer to peer networks. These networks maintain and mine virtual currencies by leveraging the blockchain technology and sharing computing power. Blockchains keep the integrity of the coins by recording each transaction and validating it. The blockchain is distributed to all the nodes in the network. Therefore, everyone in the network has a copy of the blockchain ledger at all times. This means that you can’t just change the ledger without everyone noticing.
The decentralized nature of cryptocurrencies makes it impervious to institutional interference. This means that the value of every cryptocurrency depends on actual supply and demand. Central authority, such as governments or central banks cannot censor any transaction and have no control over the price of Bitcoin or any other alt coin.
Since the introduction of Bitcoin, hundreds of other cryptocurrencies have emerged. As of today, there are over 1,500 cryptocurrencies according to CoinMarketCap. The total market capitalization of all those virtual currencies currently is over $330 Billion. The market cap even reached to above $800 Billion in January 2018. With such valuations, governments, banks, and companies have taken serious interest in its existence.
How investing in cryptocurrencies works
Investing in cryptocurrencies works similarly to investing in the stock market. You buy the asset and wait for its value to grow. However, there are key differences in terms of:
In the stock market, you have a stock exchange that regulates and oversees trading of a particular market. For example, you can trade 2,800 publicly listed companies on the New York Stock Exchange (NYSE). For some of these listed companies, you’re not able to trade their stocks other than on the NYSE. In the crypto market, you can trade cryptocurrencies on multiple exchanges. For example, you can trade Bitcoin in cryptocurrency exchanges such as Bitstamp, Coinbase and others. These exchanges are independent of each other.
When you buy stocks on a stock exchange, you use fiat (traditional currency without intrinsic value) to buy shares of a particular company. For instance, you use USD to buy shares of Johnson & Johnson. When you sell your shares, you receive USD as payment. You cannot use your Johnson & Johnson shares and trade it for Procter & Gamble shares. In the crypto market, you can use fiat currencies to buy crypto assets. However, you can also use the cryptocurrency to trade and receive other cryptocurrencies in exchange.
For example, you can purchase Litecoin using USD. Your Litecoin positions can be traded back to USD. Alternatively you can trade it for Bitcoin, Ethereum, Monero, or other cryptocurrencies. Your positions in a particular cryptocurrency is an asset that can be traded to other alt coins.
In the stock market, participants trade when the market is open. For example, you can trade in the NYSE between 9:30 am and 4:00 pm EST on weekdays, excluding holidays. On the other hand, you can trade anytime in cryptocurrency exchanges. They are open 24 hours/day, 7 days a week and on holidays.
Medium of exchange
A difference between equities and cryptocurrencies is that you can’t buy goods and services with equities. Whereas Bitcoin and other alt coins can be used as a medium of exchange (i.e. cryptocurrencies can be used as money). The idea that money should be issued by the government is becoming a relatively outdated phenomena.
Barter, gold, pieces of paper, and conventional currencies are forms of money. Money is a medium of exchange. If I believe something to be of a certain value, I can use it to trade for something else. Using cryptocurrencies is no different. You can now invest in cryptocurrencies, as well as use it as a form of payment for products and services. This includes computer equipment, books, website hosting and in some cases even cars and real estate.
Price floors and ceilings
In equity markets, governments implement price floors and ceilings to keep the markets stable. Each government has a unique strategy to protect the stock of a company from being sold unfairly. Governments also try to protect investors from buying the stock at exorbitant prices.
In some countries, trading of a particular stock halts if it drops or increases by more than 50%. This regulation is not available in crypto markets. Cryptocurrencies have the reputation for being highly volatile. They have the tendency to rise or fall by as much as 50 – 100 percent per day. There is no institution to halt cryptocurrency trading activities.
How to buy or sell cryptocurrencies
If you are interested in how to buy cryptocurrency, you have many options today. In fact, buying Bitcoin or other cryptocurrencies can be easy. Let’s have a look at the step by step process below:
- Get a wallet
- Buy your preferred cryptocurrencies
- Trade your cryptocurrencies
- Sell your cryptocurrency…or not
Step 1: Get a wallet
Keep your cryptocurrencies and private keys secure by getting your own wallet. Your private key is like a key to your vault. A private key is your seed and is usually a secret 256-bit number that you need to keep safe. If anyone has access to this phrase they have full access to your funds.
Be very skeptical of wallets that do not give you access to your private keys. Therefore, any secure wallet where you control your private keys works. The best software wallets are free and open source. Software wallets by Electrum for example, have been in the space since 2011. Electrum has some of the best Bitcoin and other alt coin wallets.
One of the better ways to hold cryptocurrencies is using cold storage and hardware wallets. Hardware wallets include Ledger, Trezor and KeepKey. These wallets can store many different kinds of cryptocurrencies. They are never connected to the internet, which makes them very secure. All these wallets do is digitally sign transactions using private keys that never leave the device. The drawback is that hardware wallets are not free.
Step 2: Buy your preferred cryptocurrencies
The second step is to purchase cryptos from a cryptocurrency and Bitcoin exchange, such as Coinbase. The broker allows you to buy Bitcoin, Ethereum and other alt coins such as Bitcoin Cash and Litecoin. You can use your fiat currency like USD or EUR. Once you buy your cryptocurrency from centralized exchanges be sure to transfer them out to your wallet. Leaving cryptocurrencies on an exchange puts your funds at risk of hackers and fraud.
You can also use decentralized exchanges, such as Bisq and Blocknet, to buy cryptocurrency. These are a much safer way to buy cryptocurrencies. You won’t need to expose your assets on a centralized platform where you don’t control your private keys. An alternative is to buy digital currencies directly from other people by using services like LocalBitcoins. If you know someone who owns Bitcoin or other cryptocurrencies, try to buy from them.
Step 3: Trade your cryptocurrencies
Now that you have cryptocurrency, you can trade it for any other digital currency. As mentioned, you can trade your cryptocurrencies in multiple cryptocurrency markets and exchanges. You have to be careful here because you need to select the most reliable cryptocurrency exchanges. Some of the most well known exchanges that trade crypto to crypto are Binance, Poloniex, and Bitstamp.
After depositing your cryptos to the exchange, you are all set to trade digital currencies. A cryptocurrency exchange can have several markets where you can buy and sell various cryptocurrencies. In Poloniex for example, participants can trade Bitcoin, Monero, and Ethereum to a number of other alt coins.
Let’s say you deposited Bitcoins in Poloniex. You can trade them to altcoins offered in the BTC market. For example, you can trade your Bitcoin into Ethereum. At current market value (April 2018), you must pay 0.06316593 units of Bitcoin to get 1.00 unit of Ethereum. You can also use decentralized exchanges as mentioned previously to trade crypto to crypto. Or a service like ShapeShift, without registration for private and secure transactions.
Step 4: Sell your cryptocurrency…or not
Ideally, you sell your cryptocurrency at a price that’s significantly higher than your purchase price. If you manage to get to this point, selling is easy. Let’s say after a month of buying one unit of Ethereum, the value has risen to 0.08 units of Bitcoin. This means that someone is willing to pay you 0.08 Bitcoin units for 1.00 unit of Ethereum. Your investment has paid off as your Bitcoin units have grown by 26.65%.
Of course, you can also invest in cryptocurrencies for the long term and not sell for 10 years or more. You may choose not to sell your cryptocurrencies since you can use them as a medium of exchange. This is one of the applications of the decentralized blockchain technology. This is especially exciting as the adoption continues to grow.
How to invest in cryptocurrencies
There are more ways than one to invest in cryptocurrencies, not just through buying and selling. Here are a few ways to starting investing in cryptocurrencies:
- Store cryptocurrency in digital wallet
- Purchase Bitcoin Investment Trust shares
- Purchase exchange traded tracker certificates
- Invest in Initial Coin Offerings (ICO)
- Invest in cryptocurrency stocks
- Cryptocurrency mining
Store cryptocurrency in digital wallet
The basic principle is simple. Buy units of your preferred cryptocurrency and leave it there for months or years. After some time, there’s a good chance that the selling price is higher than your purchase price. For example, a Norwegian man bought $27 worth of Bitcoin in 2009. As of this writing, the man’s Bitcoin is worth $40,445,000.
Purchase Bitcoin Investment Trust shares
Instead of buying Bitcoins outright, you can still bet on crypto. The Bitcoin Investment Trust (GBTC) holds Bitcoins on behalf of its investors. Each share represents about 0.092 units of Bitcoin. The trust will buy the Bitcoin for you, and charge you a management fee of 2% per year. The value of each share may grow as the Bitcoin price soars.
Purchase exchange traded tracker certificates
Investors can also invest in exchange traded tracker certificates (ETCs) from XBT Provider by CoinShares, which is a Swedish company with statutory seat in Stockholm. These ETCs are designed to mirror the return of the underlying asset, U.S. dollar (USD) per Bitcoin or Ether. That means you can participate from the performance of Bitcoin and Etherium. The ETCs can be traded on various regulated stock exchanges in Europe.
Invest in Initial Coin Offerings
You can also invest in Initial Coin Offerings (ICO). This is similar to Initial Public Offerings (IPO) in the stock market. The company behind the ICO sells positions or tokens to raise funds. It is important to note that the token does not confer rights to company ownership. Be careful with these investments as many of them are scams.
In addition, you can invest in cryptocurrency companies by donating through crowdfunding platforms like BnktotheFuture. When investors donate, they enjoy the rewards listed on the benefits page. Some companies offer ownership rights to investors. Be careful here as well and perform thorough due diligence before investing.
Invest in cryptocurrency stocks
Companies that are embracing the blockchain revolution can be invested in using stocks. For example, companies like IBM, Intel and Nvidia have shown some signs of utilizing the blockchain technology for their respective industries. There also are companies like Bitcoin Group SE with a business model that is directly involved in cryptocurrency or blockchain. With an investment in cryptocurrency stocks you can participate from the crypto niche.
Alternatively, you can invest in exchange traded funds (ETFs) that hold such companies. For example, there’s an ETF called Reality Shares Nasdaq NexGen Economy ETF (BLCN). It holds companies that utilize the blockchain technology. The ETF determines its holdings based on a rules-based algorithm.
Another way to invest in cryptocurrencies is by becoming a miner. Your job is to verify, add and secure transactions to the blockchain and mine cryptocurrencies. Mining is proof of work that is used to determine consensus in the network. This involves solving complicated math problems. Miners get a share of the profits every time a block is solved and added to the blockchain.
To start mining, you need to purchase specialized gear like Application-Specific Integrated Circuits (ASICs). You can also use very powerful graphic processing units (GPUs). These are also referred to as computer graphic cards. They are used to mine certain types of cryptocurrencies.
However, it’s not necessarily required to dive into the technical aspects of cryptocurrency mining. Companies like Genesis Mining offer cloud mining services where you can start mining Bitcoin or other cryptocurrencies by purchasing a mining plan. You’re basically paying Genesis Mining for running the hardware and infrastructure that is necessary for cryptocurrency mining. Cloud mining is an easy alternative to get involved in mining cryptocurrencies.
How to earn from cryptocurrency investments
There are various ways to earn from cryptocurrency investments. Some of the most popular methods are:
Buy and hold strategy
Many cryptocurrency investors rely on the buy and hold strategy. They buy Bitcoins or other cryptocurrencies and hold them for the long term. Thus riding out the highs and lows of the market. For instance, those who bought in March 2017 when Bitcoin’s market value was $1,000 would have grown their investments by over 700% if they sold today. If you believe in the blockchain technology and cryptocurrencies like Bitcoin, then buy and hold could be your preferred long-term investment strategy.
Trade using technical analysis
Those who have experience in investing and trading can earn with cryptocurrencies. By looking at historical price action, traders may sometimes predict market movement through technical analysis. They use various strategies to make this happen. Though, the idea is simple: buy low and sell high to generate profits.
Accept cryptocurrencies as payment
As a business or a freelancer, you can earn by accepting cryptocurrencies as a payment. Big businesses such as Overstock, Expedia, and Microsoft accept Bitcoin as a payment.
What are the fees for cryptocurrency transactions
Cryptocurrency users have to deal with two different types of fees:
- Trading fees
- Transaction or mining fees
When buying cryptocurrencies from exchanges you encounter trading fees. Exchanges are often the first point of entry for anyone investing in cryptocurrency. Whether you want to buy / sell cryptocurrency or trade for other cryptocurrencies, you often need to use exchanges. Users pay a commission for each trade on these exchanges for digital currencies. Each exchange charges differently, so make sure to do your research.
Next, you also have to pay for network fees. These are paid to cryptocurrency miners who verify the number of transactions in a block. These fees are paid every time a transaction is broadcasted on the network. The sender is usually the one paying for this transaction fee.
What are pros and cons of cryptocurrency investments
As with all other investment types, investing in cryptocurrency comes with its own risks and rewards. It offers the potential of great returns on your investment, but it also comes with high risk and volatility. To decrease this risk, you need to educate yourself about the pros and cons of this venture.
Huge profit potential
One of the major reasons of investing in cryptocurrency is its massive potential for returns. For instance, $1,000 worth of Bitcoin in 2013 would be roughly equivalent to $400,000 today. Some investors are even predicting that the value of Bitcoin will increase to as high as $1 million in the next 3 years.
Transition into a legitimate currency
It looks like cryptocurrency is here to stay. Some big companies are even beginning to accept Bitcoin as a form of payment, making it more mainstream. It’s highly probable that cryptocurrency will be common payment form in the future, which makes it a good long-term investment.
Low barriers to entry
Perhaps most importantly, the barriers to enter the world of cryptocurrency are minimal. No one can prevent you from having a cryptocurrency wallet. There is also no minimum amount to invest, and your investment cannot be limited or denied. You only need a device with internet access to buy, sell, and earn from cryptocurrencies.
While the factors mentioned certainly make cryptocurrency attractive, you also need to be aware of potential downsides. This is because you should enter the market with a balanced perspective. For instance, cryptocurrencies remain highly volatile. This means the cryptocurrency market is high risk. The market is still very young, and coin prices can shift by hundreds or thousands of dollars in just one day, making some users wary of jumping in.
Scams and fraud
Hundreds of coins are becoming available for purchase, but not all of them will be profitable. Some cryptos work like penny stocks. They are vulnerable to pump and dump schemes so you have to be careful in choosing which ones to invest in. There are also alot of scams, such as Bitconnect. Some people also used cryptocurrencies for the purposes of money laundering and tax evasion. This accounts for a very small subset of users though. Though, it still hurts the cryptocurrency reputation and may affect the rise of cryptocurrencies and enforce regulation by governments.
While coins like Bitcoin or Ethereum have markets with good liquidity, many alternative coins can be considered illiquid. This means that it is difficult to sell these coins because buyers are too few. When buying alt coins, always look at its daily trading volume and market capitalization. The higher the figures, the more liquid the market.
Conclusion: Investing in cryptocurrencies and blockchain technology
There are many arguments for investing in cryptocurrency. It seems digital currencies are here to stay and may become the main medium of exchange of the future. On the other hand, when you invest in digital currencies you quickly find yourself in an unregulated wild west market with significant risks involved. Whether you think that cryptocurrencies are a great long-term investment or that we’re currently having a cryptocurrency bubble, digital currencies definitely is something you should have on your radar. What are your thoughts on cryptocurrencies?