How To Invest In Cryptocurrency: What You Should Know Before Investing
Did you jump into cryptocurrency investing before the bubble? Are you thinking of getting in now, perhaps with some lower-priced alt-coins like Doge? Maybe you plan to buy some fractional shares of Bitcoin or Ethereum, the two most common cryptocurrencies on the market today.
If crypto has recently piqued your interest as an investment, you’re not alone. Even electric vehicle manufacturer Tesla recently invested $1.5 billion in Bitcoin, a step that CEO Elon Musk called “adventurous enough for an S&P 500.”
While Musk has personally tweeted his interest in both Doge and Bitcoin, he only went so far as to call Bitcoin a “less dumb form of liquidity than cash.” In the same tweet, he noted that “Tesla’s action is not directly reflective of my opinion.”
Is Cryptocurrency Considered an Investment?
With all the buzz Bitcoin and other cryptos have been generating lately, you might be surprised to learn that, as of 2019, only 6.2% of Americans own bitcoin, while another 7.2% revealed plans to buy some, according to a study from Crypto Radar.
If it’s not widely accepted as currency, that puts crypto firmly in the category of investment. And, in fact, major banks are looking to classify Bitcoin as a separate asset class.
But for everyday people and retail investors, all the publicity surrounding Bitcoin can only make cryptocurrency even more confusing to understand.
This guide offers an introduction to cryptocurrency, including how to invest in cryptocurrency.
What Is Cryptocurrency?
Cryptocurrencies are digital assets used to verify the transfer of funds and to secure information without a third-party intermediary. They function on a decentralized ledger called a blockchain — think of it as a digital transaction log — with special encryption techniques to protect privacy and expedite transactions.
Lack of Centralization
Blockchain’s function as a decentralized ledger makes it unique. It doesn’t need an intermediary like a central bank clearing system or financial institution to ensure the exchange between two parties.
Instead, you pay someone directly on the peer-to-peer network, and the individual who clears the transaction receives a small fee for their time. The payment is timestamped into a block of the digital transaction log — the ledger — which makes the transaction transparent and permanent.
The lack of centralization means that governments do not control cryptocurrencies. Instead, cryptocurrencies are hosted on networks and computers around the world.
Today, as Bitcoin achieves record highs of over $50,000 per coin and Ethereum sits behind it at over $1,700 per coin, many investors want to learn more about how to invest in this next-generation currency.
How To Invest in Cryptocurrency
Direct investing allows investors to buy the cryptocurrency and then decide when to hold and sell. It also:
- Allows investors to maximize returns.
- Gives investors complete control over their crypto purchase.
- Provides investors with the opportunity to learn how to invest on the fly.
- Allows investors to choose how much they want to invest and grow confidence over time.
To make a direct investment in cryptocurrency — buying the actual currency — is fairly easy. You can even purchase Bitcoin through the PayPal payment platform.
- Select a currency. Choices range from the “meme-crypto” Dogecoin to the respected Bitcoin.
- Choose your digital wallet. You can opt for an app that resides on your smartphone to a hardware-based wallet, which is an external hard drive for your computer used for only crypto.
- Select an exchange where you can purchase the crypto you want.
Benefits and Risks of Investing in Cryptocurrency
Cryptocurrency provides investors with some benefits they can’t receive from buying equities on the stock market.
- Blockchain projects grow to be more commonly used for everything from e-commerce payments to traditional banking, the value of crypto will grow.
- Crypto is already convenient to own and transfer between parties.
- Transactions are also anonymous and highly transparent, which many people prefer when it comes to dealing with purchases.
But several risks exist that investors must tolerate when dealing with cryptocurrencies like Bitcoin.
- Crypto has experienced volatility and wild price swings in recent years.
- Because the currency is 100% virtual — there’s no physical option — and is not backed by any centralized government or central bank, it’s is susceptible to cyber theft.
- Accounts are not guaranteed by the Federal Deposit Insurance Corporation like the U.S. dollar is by banks.
Good To Know
The price of Bitcoin swung up and down thousands of dollars during June 2019. Investors aren’t certain if the current rally will continue or if Bitcoin’s $50,000+ price per coin may crash in the future.
It’s important to note that many cryptocurrency projects have been fraudulent or failed in recent years. It’s important to research carefully before investing. Certain projects are subject to failure due to a lack of investor confidence.
Buying and Selling Crypto and the Effects on Your Taxes
As with any financial transactions, you need to be transparent with the IRS when you buy and sell crypto, reporting any earnings as income. You may also be able to write off losses, so track all your transactions carefully.
Coinbase uses IRS Form 1099-K to report payments to cryptocurrency traders if the traders made over 200 transactions with a total value of over $20,000. Any large volume of assets moving into or out of bank accounts may attract unwanted attention from the IRS, so you want to manage your crypto “by the books,” so to speak.
The IRS classifies crypto investments as capital assets, like property. This means that sales and profits follow the same rules on capital gains. A person who sold Bitcoin at a profit within the last 12 months would report short-term capital gains on their tax form. These profits would be taxed at the same rate as your income, based on your tax bracket.
You can report cryptocurrencies bought and sold for profit after a year as long-term capital gains, which classifies the proceeds as investment income. Losses accrued on trading can be counted toward the $3,000 in capital losses allowed as deductions. Anything over that level must be counted in future years, according to the IRS.
Buying and selling cryptocurrency is subject to volatility. Even if you sold your cryptocurrency for a profit last year and lost it all this year, you will still owe money for your capital gains during the previous year. Track all your expenses associated with crypto, including the computer or mobile device you trade on, as well as your internet service costs, to help reduce your taxable income.
It’s a good idea to consult with a tax professional to ensure you’re declaring all the deductions you deserve. It’s equally essential to stash a portion of your earnings away for the IRS.
Should You Invest in Cryptocurrency?
Cryptocurrency investing isn’t for the faint of heart because of its volatility and the technological knowledge required to trade it. Before investing in a cryptocurrency project, consider the following:
Items To Consider:
- The business proposition and social mission: Is the use of blockchain and crypto solving a practical issue? Is there a viable problem, and does this project offer a solid business case for resolution?
- The supply of crypto: Most coins go through a process known as mining, which impacts the total supply of available currencies and their price now and in the future. Bitcoin, for example, has a fixed number of coins –just 21 million– which will affect supply and demand in the future.
- Price history: Cryptocurrencies are historically volatile. But it’s important to weigh price history with these other elements to determine why prices are rising and falling. Some cryptocurrencies have been affected by pump-and-dump schemes, for example, which occurs when large groups of buyers purchase the coin to increase the value and then sell when it reaches a market high. Those left behind could lose big.
- Community activity: A larger community around a cryptocurrency is a good sign of its health and interest in the project. A strong, active community will put pressure on developers to fix bugs, advance the project to new stages and find new test cases and value for the projects.
Another option is to invest indirectly by putting your money in investments that might benefit from cryptocurrency and/or blockchain taking off. You can choose this option if you want to be in the cryptocurrency space and:
- Worry about the short-term volatility in the price of Bitcoin or other cryptocurrencies
- Want to invest a very large amount while mitigating risk
- Lack the time to consistently monitor the price of cryptocurrencies on a day-to-day basis
- Believe in cryptocurrency but wish to capitalize more from the infrastructure and community instead of the currencies
Indirect investors might consider any of the following options:
- Publicly traded companies like Overstock, which is building blockchain projects
- Crowdfunding projects dedicated to new blockchain programs or ancillary projects
- IRA investments that take a long-term outlook on blockchain disruption and benefits to the global economy
Frequently Asked Questions About Investing in Cryptocurrency
If you’re still unsure about investing in cryptocurrency, check out the answers to some common questions about it:
Why is it a good idea to invest in cryptocurrencies instead of other investments?
Cryptocurrencies have netted some investors significant sums of money in a small amount of time, although many others have lost large sums in just months. Bitcoin and other cryptocurrencies are better long-term investments tied to the adoption of blockchain across the global economy.
Should I invest in multiple currencies or just one?
Investors are encouraged to diversify across many different assets. Owning more than one cryptocurrency ensures protection that all of your investment won’t be lost to one failed blockchain project.
But investors merely looking to put a small amount into cryptocurrency should consider Bitcoin and Ethereum. They are the largest cryptocurrencies by volume. Bitcoin is seen by many as a store of value, whereas Ethereum is seen as an investment in the backbone of future blockchain functionality.
Is it wise to use multiple wallets and cryptocurrency exchanges?
Using multiple wallets and exchanges is a popular way to reduce exposure to cybercriminals and hackers. But risks exist in this process: For example, passwords to wallets and exchanges are typically very complex. Failure to recall a key to a wallet can result in the permanent loss of cryptocurrencies stored on these wallets.
Is cryptocurrency safe? Can I get hacked?
Like all investments, risks exist. Several high-profile investors have lost their key phrases, passwords and wallets containing hundreds of thousands, if not millions, of Bitcoins.
Cryptocurrency exchanges have also faced large-scale attacks that led to the complete collapse of these networks and the loss of investors’ capital.
The most famous hack occurred in 2014 when Japanese exchange Mt. Gox was hacked. Cybercriminals made off with $460 million, and users are still trying to recover pennies on the dollar.
Are there crypto investment strategies?
A variety of cryptocurrency investment strategies exist for beginners and advanced traders. One of the more popular ways to invest in cryptocurrencies is to use a process known as “dollar-cost averaging.” In this situation, investors would purchase a set amount of a cryptocurrency every week, month, or quarter to reduce exposure to volatility.
Other strategies include traditional long-term investment options like “buy and hold” and “buying on the dip.” But nothing is quite as reliable as reading white papers and forums, getting to know the projects and buying the cryptocurrencies that you believe will change the world.
GOBankingRates’ Crypto Guides
- What Is Cardano? (ADA)
- What is Bitcoin Cash? (BCH)
- What Is Chainlink? (LINK)
- What Is Dogecoin? (DOGE)
- What is Litecoin (LTC)
- What is Polkadot? (DOT)
- What is Ripple? (XRP)
- What is Stellar (XLM)
- What is Tether? (USDT)
Dawn Allcot contributed to the reporting for this article.