Investing in cryptocurrency is an exciting prospect for many people who are interested in personal finance. Earning huge returns on a small investment is a possibility and cryptocurrency represents an alluring option for anybody looking to diversify their portfolio.
Our Addition Financial members have been asking us about cryptocurrency investing and we’re here to help. In this post, we’ll explain the risks and rewards of investing in cryptocurrency, along with some advice about which cryptocurrency to buy and how to invest to minimize your risks and maximize your earnings.
What Are Some Ways to Invest in Cryptocurrency?
When most people think about investing, they think about stocks, bonds or possibly other things that appreciate in value, such as real estate or artwork. Since the very first digital coin was minted back in January of 2009, interest in cryptocurrency investing has increased.
It can be a bit confusing to talk about investments because cryptocurrency is currency. However, the IRS views it as property and if you make money crypto trading, you will probably be on the hook to pay capital gains tax, just as you would with a stock sale.
There are a few ways you can invest in cryptocurrency:
- Buy cryptocurrency directly. There are a number of cryptocurrency exchanges where you can purchase Bitcoin and other currencies. A cryptocurrency exchange is a cryptocurrency market. To buy cryptocurrency, you’ll need a crypto wallet and access to an exchange. (We’ll go into greater detail about both in our guide, below.)
- Invest in companies with crypto interests. Companies in many industries are putting their working capital into Bitcoin or, in some cases, making cryptocurrency mining equipment such as ASICS or GPUs.
- Invest in blockchain or crypto ETFs. Exchange traded funds, or ETFs, are a less risky investment than individual stocks because they spread the risk across multiple companies.
- Invest in blockchain technology. Buy stock in companies (or funds that include such companies) that have adopted blockchain technology or are developing new uses for it.
You should know that cryptocurrency investing can be a high-risk endeavor. Compared to other investments, cryptocurrencies and NFTs are volatile. Their value can change drastically even in a short period, which means that investors can gain (or lose) a lot of value without warning.
What Are the Risks of Investing in Cryptocurrency?
The prospect of investing in cryptocurrency is an alluring one for many, but we believe it’s important for our members to understand the very real risks associated with crypto investments.
There’s always risk in buying stock. A company’s stock value may rise or fall. Some investments are riskier than others. For example, it’s far riskier to invest in a start-up company than it is to invest in a company with a long track record. The start-up could take off and your stock could increase dramatically in value, or the start-up could fail and your stock might be worthless.
Cryptocurrency has value because people believe it has value. When many people want to buy Bitcoin, for example, the price increases. When people sell their Bitcoin and fewer people are buying it, the price can plummet. There are several risks that you should be aware of before you buy crypto.
#1 Price Volatility
We’ve already mentioned that the prices of cryptocurrency are volatile. The price of any stock rises and falls but cryptocurrency prices often move dramatically from hour to hour. To help you see how volatile prices can be, let’s look at the progression of Bitcoin over a short period:
- March 2017: $1,290
- September 2017: $5,013.91
- December 2017: $19,783.06
- February 2018: $6,200
- December 2018: $3,300
As of this writing, Bitcoin is trading at $40,007.70. It has been more than $60,000 in 2022, but price fluctuations of up to 50% are not uncommon. We’ve used Bitcoin as the best-known example, but it is also one of the least volatile virtual currencies on the crypto market.
#2 Price Manipulation
Because the prices of cryptocurrencies change quickly, there’s a lot of room for price manipulation. Well-known investors can affect the price of any coin by what they say about it. Crypto exchanges and media owners can also impact the prices, sometimes to their own benefit and the detriment of other investors.
#3 Scams and Frauds
Anytime large amounts of money are at stake, there’s the potential for fraud. While blockchain technology offers a lot of security, it’s essential for any investor to be aware of scams and frauds. A scam might involve the launch of a new coin or attempted duplicate transactions.
#4 Hacking
Anybody who buys or sells cryptocurrency needs a crypto wallet. A crypto wallet may be hot or cold. A hot wallet is one that’s connected to the web and thus vulnerable to hacking. It’s essential to store your cryptocurrency somewhere safe to minimize your risks.
#5 Lack of Regulation
Decentralization is part of the appeal of cryptocurrency but it’s also a risk. The US government regulates the stock market and any financial instruments related to the US dollar, but as of April 2022, it does not regulate cryptocurrency in any way.
The lack of regulations means that investors have no recourse if something goes wrong. It’s important to keep that in mind. The FDIC insures bank deposits but does not insure crypto wallets.
Guide to Investing in Cryptocurrency
If you do want to start trading cryptocurrency, here are the steps to follow.
#1 Get a Crypto Wallet
The first step is to get a crypto wallet. As we mentioned above, we recommend a cold wallet, which gives you three choices:
- A desktop wallet on a laptop that is not connected to the internet and never will be.
- A hardware wallet (similar to a thumb drive) that you can store in a secure location.
- A paper wallet with encryption and QR codes that you can store in a secure location.
Many investors consider a paper wallet to be the safest option. If you choose to go that route, you must be sure to store it in a safe place. If you lose a paper wallet, you will not be able to recover your cryptocurrency.
#2 Sign up for a Crypto Exchange
The next step is to sign up for a cryptocurrency exchange. As a beginning investor, your best bet is to choose an exchange with user-friendly features and low rates. Coinbase is the best-known exchange, and we like them because they reward investors with cryptocurrency if they use the Learn platform to educate themselves about crypto.
Other options we like include Crypto.com, which has the best mobile app, and KuCoin, which has affordable rates and offers discounts if you pay with their proprietary stablecoin, KCS. We also like Gemini, which offers a unique benefit by insuring the contents of users’ hot wallets.
You may also be able to buy crypto within a 401(k) or IRA.
#3 Decide How Much to Invest
When people are investing for retirement, it’s usually recommended to set aside a percentage of your salary consistently and spread out your risk. With cryptocurrency trading, our recommendation is to approach investments the same way you would a visit to a casino. What we mean by that is that you should never invest more than you can afford to lose.
If you prefer a percentage guideline, we suggest starting with no more than 5% of your portfolio in cryptocurrency. Make sure to do your research before buying.
#4 Research Cryptocurrency or Crypto Stock
After you’ve decided how much to invest, it’s time to choose your investments. There are over 10,000 types of virtual currency in existence, but many are likely to come and go without much impact. Here are five cryptocurrencies we think are good for beginners:
- Bitcoin
- Bitcoin Cash
- Litecoin
- Ethereum
- Cardano
Just as it makes sense to minimize how much of your portfolio you put into digital currency, it also makes sense to allocate your risk across two or more types of currency. Keep in mind that you can buy part of a Bitcoin, so you don’t need $40,000 to get started.
The other option is to forego buying cryptocurrency directly and buy crypto stock or blockchain stock instead. The same caution about diversification applies here.
Our final word of caution here is that, as a rule, it’s best to view cryptocurrency as a short-term investment. Keep an eye on it but, depending on your risk tolerance level, you may want to avoid checking it every day. It can be a roller coaster ride! You should monitor your risk allocation and change your portfolio accordingly.
How Do You Cash Out Cryptocurrency?
Cashing out cryptocurrency isn’t difficult but it does have tax implications. If you use a big exchange such as Coinbase, you can simply sell your cryptocurrency and withdraw funds to your wallet.
As we mentioned above, the IRS views cryptocurrency as property and capital gains taxes may apply. If you have held the crypto asset for under a year, you’ll pay the short-term capital gains tax rate, and if you’ve held it over a year, you’ll pay the long-term rate.
Keep in mind that if you buy cryptocurrency inside of a tax-deferred investment portfolio such as an IRA, you can defer paying taxes on your gains until you begin to make mandatory withdrawals.
If you want to become a crypto investor, the brief guide we’ve included here can help you to make informed decisions about how much to invest and which coins or stocks to buy.
Do you need help managing your crypto investments? Click here to learn about the MEMBERS Financial Services Program and schedule an appointment today.
Posted on May 20, 2022
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