Bitcoin and cryptocurrencies as a whole are coming off a historic year and more people than ever are showing interest in investing. Global events had a lot to do with it, but to those who’ve been monitoring cryptos for a while, it was only a matter of time before they blew up.
While cryptos have gained mainstream attention, it is still one of the most misunderstood classes of assets you can find. Investing in crypto is also a bit more complex than investing in stocks or mutual funds. Let’s take a look at how you can invest in cryptocurrency in 2021, a few terms you should get familiar with, and a few things you should watch out for.
The first thing you should do before investing in cryptocurrencies is understanding how they work. Blockchain is a term that you’ll often hear when talking about crypto, and while both are intertwined, you have to differentiate the technology from cryptocurrencies. In short, most cryptocurrencies operate on a blockchain, but not all blockchains are for crypto.
The blockchain is a distributed ledger system. It uses computers in a network to verify transactions. This network can be centralized and decentralized, and the blockchain is made of a series of blocks with each showing proof of a transaction.
These blocks will be strung together to show every transaction ever made over this network. Since it will be distributed to every computer on the network, it is difficult to falsify unless a group or individual gets control over most of the network’s computing power, which is virtually impossible on a massive decentralized network like the ones bitcoin uses.
You should also know that not all cryptocurrencies are meant to be used as money. Some like Bitcoin, Litecoin, and Bitcoin Cash are trying to replicate the action of actual currencies. Others have different goals. Ether, which is the second coin in terms of market capitalization, was never actually meant to be a currency. Instead, it is meant to be used to power applications on its proprietary blockchain.
Other cryptocurrencies, like XRP, for instance, were made to support legacy systems by offering a faster way to perform international remittances and cash transfers. There are many of those types of specialized coins, and you must get familiar with them before getting started.
There are many different types of cryptocurrencies on the market, but most of them fall into 5 main categories: platform coins, transactional coins, stablecoins, utility coins, and governance coins.
Platform coins are meant to be used on a specific platform, like Ether. But many other projects use platform coins, and it’s always wise to learn about these projects to see if they have potential. Golem, for instance, allows people to rent the computing power of computers on the network. Users can upload tasks to the Golem supercomputer through the cloud and play using the platform’s proprietary token, the GNT.
Transactional coins are coins meant to mimic real-world currencies, like Bitcoin. However, while they try to replicate how fiat money is transacted, they can also have significant advantages. For instance, coins like Bitcoin and DAI allow users to exchange money without an outside entity like a bank.
Stablecoins are a special type of cryptocurrency that is pegged to a more stable underlying asset. The main reason for their existence is to allow users to easily exchange cryptocurrencies. Many cryptocurrency exchanges make it difficult for people to trade fiat money for crypto, and these allow you to have exposure to the crypto market without having to deal with its wild fluctuations.
Utility coins are usually integrated into a blockchain protocol and the coins allow you to access services on that network. An online casino releasing its own cryptocurrency to allow players from all jurisdictions to play would be an example of a utility coin.
Governance coins are a special type of coin that is used as a voting tool for administrators and stakeholders on a blockchain. Governance coins are used to show support for certain initiatives or proposed changes.
Now that we know a bit more about cryptocurrencies, let’s take a look at how you can buy and trade them.
The very first thing you will need to look at when investing in cryptocurrency is a safe cryptocurrency wallet. You should know that a cryptocurrency wallet doesn’t “hold” any of your cryptocurrency per se. What it does is protect your public and private keys, which are essential for verifying transactions on the blockchain and confirming that you are the owner.
If you don’t know what a private and public key is, this is a concept you’ll have to understand before starting. A private key should never be shared and needs to be safeguarded at all times. Try to think of it as the key to a mailbox. The public key in this example would work as the address.
Everyone should be able to see your address so they can send you money, and people knowing your address does not give them access to your mailbox. But, if they can get their hands on your key, they can help themselves to whatever’s in it.
This is why you need to find a wallet that will ensure that this key is properly encrypted. Limiting access to this wallet is also recommended. This is why most people will suggest that you use cold storage for large amounts of crypto.
A cold wallet will only be connected to a network when you wish to connect. This type of storage usually looks like your average USB key. It limits the chances of your wallet getting hacked. But it also means that it can be lost, and losing a wallet means that you could lose all of your crypto, which has happened many times before. So, you will also need to find a secure place for this wallet, like a bank security box, for instance. It would also be wise to not put all of your assets in one wallet.
The other common type of wallet you will find is the software wallet. These are usually used on mobile phones. These are very convenient and very secure depending on which one you pick and your device, but they will never be as secure as a cold wallet. They are a good option if you want the convenience or only want to hold and transact small amounts.
You also have the option of storing the crypto on the exchange you’re going to use, but it’s not recommended. This means that the exchange would be in control of your money at all times, and some have gone under in the last years. Some have even seen the owner vanish. So, this is not something anyone serious about investing in crypto should do.
Next, you need to look for a good exchange to buy and trade cryptocurrencies. These aren’t as tightly regulated as stock exchanges, so you need to be very careful there.
Check how long the exchange has been in operation. Where the exchange is based is also important. You also have to look at the security measures they have in place. Things like 2-factor authentication and KYC verification are all good signs. Also, look for things like SSL encryption and make sure that the majority of assets are in cold storage with routine encrypted distributed backups.
Other things to look for include customer service, user-friendliness, the number of cryptocurrencies they have to offer, and whether they allow for fiat to crypto transactions.
There are also peer-to-peer exchanges that will allow you to trade directly with other users. These have many benefits, but a few drawbacks as well.
The biggest benefit is that the transaction fees are lower. The coins are never in possession of a central authority, which means fewer chances for large-scale attacks. But centralized platforms have something that decentralized peer-to-peer platforms don’t: liquidity.
More liquidity eventually means that you have a greater chance of getting the best price on the market. There is also more control over prices on centralized platforms since transactions are moderated.
First of all, we would advise that you only invest a small portion of your portfolio in crypto. Investing more than 10% at this point would be considered risky. You also need to learn how to read a whitepaper, and how to invest in projects rather than the hot crypto of the day.
Check if a project is credible and has potential. To do this, look at the team behind it. If it consists of people who have worked on important projects and they’re respected by the community, it is a good sign. Finally, know that there is more than Bitcoin and the usual names you’ll hear being thrown around, so keep your ears and eyes open for new projects; they’re often the ones with the most growth potential.
Investing in cryptocurrency is different from investing in traditional assets in many ways. They’re also very different as an asset class. Follow these few tips and make it your responsibility to learn as much as you can about any crypto and cryptocurrencies before taking a position.