Cryptocurrency investing can be an incredibly lucrative venture but can also be quite risky, intimidating, and confusing.
Firstly, we should make the distinction between investing and trading – the biggest difference being the time horizon. With investing in any asset, it is a disciplined plan to meet specific financial goals over a longer period of time, usually five years or more. Investors may build a strategy in order to save for college, buy a house, or plan for retirement.
Trading, on the other hand, is short-term and often more speculative in nature. It is not uncommon for traders to execute dozens of trades a day in order to take advantage of intra-day price fluctuations. However, trading is not any less disciplined as investing since successful traders carefully manage their exposures.
Here, we will focus on investing in Cryptocurrencies. The most popular cryptocurrency investment method is to buy Bitcoin and Ether and different altcoins directly by buying the digital currency outright.
Investing in cryptocurrency has become more advanced with the introduction of crypto derivatives, such as futures. We also have more and more exchange-traded funds (“ETFs”) that invest on behalf of investors in physical cryptocurrencies or futures.
Lastly, there is also an investment case for buying stocks in publicly-traded companies that focus on the industry, such as Centralized Cryptocurrency Exchanges (“CEXs”) and crypto-specific hardware manufacturers.
Investing in cryptocurrency can be lucrative but also risky.
Before investing in any cryptocurrency, it is useful to conduct proper due diligence and fundamental analysis.
Investors should decide how to participate in cryptocurrencies, either directly or through other buying the digital currency, or through futures, ETFs, or crypto-related companies.
Cryptocurrency Investing Strategies
Normally, the first step in investing would be to look at asset allocation. Simply put, asset allocation means spreading out your investments across various instruments to provide diversified returns over the long run. The same applies to cryptocurrencies – you should decide on your risk tolerance, financial goals, and timeframe to decide how much of your investment portfolio can be allocated to cryptocurrencies.
Next, a prudent investor would be to look at a fundamental analysis of their desired investment. Fundamental Analysis (“FA”) is the method of assessing the intrinsic value of a security and then comparing its current market price to help with investment decisions.
While FA works well for traditional assets, like stocks and bonds, it doesn’t work as well for cryptocurrencies. However, there are some useful fundamentals to consider:
Whitepaper, Team, and Goals – This type of research is important to understand the cryptocurrencies’ purpose, technology, and use case. Understanding the team also gives you a sense of the track record of the people responsible.
Network Value-to-Transactions (NVT) Ratio – NVT provides a measure of a network’s value based on the value of transactions it processes. Cryptos with lower NVT ratios are considered undervalued, while those with higher ratios may be considered overvalued.
Price-to-Mining-Breakeven Ratio – This ratio attempts to look at the price of a digital coin versus the costs to produce it in a Proof-of-Work protocol. A digital coin with a lower breakeven ratio is more profitable.
On-Chain Metrics – These metrics try to provide a clearer picture of the activity for that blockchain. Metrics might include Transaction Count and Value, Active Accounts, and Hash Rate.
When you are ready to invest, you will need to also consider how you want to invest. Popular cryptocurrency investing strategies include buying fractions of cryptocurrencies, volatility-based investment strategies, dollar cost average investing, buy and hold investing, profit-taking investing, and lump-sum investing.
Further, volatility-based investing is easier to achieve with cryptocurrency derivatives like cryptocurrency futures contracts, cryptocurrency put options, and cryptocurrency call options. Leverage can also be used to invest in cryptocurrency via margin accounts, which uses borrowed money to increase the exposure to an investment and amplifies both potential gains as well as losses.
Additionally, due to the volatile nature of cryptocurrency, you may want to consider risk management strategies, such as regularly taking profits when investing in cryptocurrency, using stop-loss limit orders, rebalancing your crypto holdings, and ensuring diversification.
How to Start Investing in Cryptocurrency
In order to start buying and selling cryptocurrencies, you can transact with Centralized Crypto Exchanges (“CEX”), Decentralized Exchanges (“DEX”), and via Crypto Brokers. Popular Crypto Exchanges are Binance, Coinbase Exchange, Kraken and KuCoin.
Examples of DEXs include Uniswap, PancakeSwap, dYdX, and Kyber. There are also crypto brokers, such as Coinbase, Crypto.com, Gemini, and SoFi. Each of these channels has its own pros and cons that we cover in detail here.
If you decide that you want to hold the cryptocurrency yourself, you may also need to decide the best type of wallet to use. Crypto wallets help store the precious private keys that allow you to prove your ownership of the digital asset, which is always stored on the blockchain.
We’ve also seen standardized futures markets pop up for Bitcoin and other more liquid cryptocurrencies, such as Ethereum. These futures markets allow institutional investors to trade contracts or agreements or buy and sell cryptocurrencies at a pre-agreed later date in a developed and transparent manner via established exchanges.
It allows investors to not only buy a future claim to a digital currency but also take a negative view of that cryptocurrency and sell it short. These futures are cash settled, and by going through an exchange, trades are conducted in an established and regulated marketplace.
You may also choose to invest in cryptocurrency via specialized Exchange Traded Funds, called ETFs for short, that invest specifically in Bitcoin and other cryptos. An ETF is sort of like a mutual fund but is bought and sold over an exchange, so they have decent liquidity.
ETFs tend to be very lightly managed, instead of tracking the performance of an asset or an index and, as such, typically charge lower fees than a traditional mutual fund. ETFs try to mimic the performance of the underlying cryptocurrency.
Investing in cryptocurrency companies involved in the broader Decentralized Finance (DeFI) universe is another way of indirectly investing in cryptocurrencies, such as Bitcoin. As the underlying cryptocurrency does well, such companies, which may create new blockchain protocols, act as an intermediary (like CEXs) or even build specific products for mining, which can be very lucrative and profitable.
Companies that are publicly traded and focus on cryptocurrencies include Coinbase Global Inc., Marathon Digital Holdings Inc., and NVIDIA Corp.
For more sophisticated investors, there are dedicated hedge funds that specialize in cryptocurrency, digital assets, and/or DeFI investments that professionally manage money on behalf of investors. Such funds generally require larger minimum investments upwards of US$100,000.
The companies can invest in single digital coins, crypto start-ups, exchanges, Initial Coin Offerings, Initial Exchange Offerings, and other blockchain assets. In return for their professional management, they charge their end investors a hefty fee.
Lastly, one may also consider investing in cryptocurrency through a self-directed IRA or other similar registered retirement vehicles to achieve tax advantages. It can be especially advantageous with the large returns seen through cryptocurrency investing. Still, please consult with your tax or financial planner.
Thank you for reading CFI’s guide on How to Invest in Cryptocurrency. To keep learning and developing your knowledge, we highly recommend the additional resources below: