If you’re investigating how to invest money, then you likely know that one of the biggest investing trends right now is cryptocurrency. The idea of using this new asset class to grow your wealth can be an attractive one. However, before you dive into cryptocurrency as a beginner, it’s important to understand how virtual currency works and what risks come with it.
In this beginner’s guide, we give you an idea of whether putting your money into these digital assets is the right move for your situation.
What is cryptocurrency?
A cryptocurrency is a digital currency created out of computer processing power. Often, these currencies make use of cryptography to secure transactions, and many use blockchain technology (a decentralized peer-to-peer network). Blockchain technology focuses on secure ways of recording transactions and distributing them throughout all the network computers.
It’s important to note that cryptocurrencies are decentralized, which means they aren’t controlled by a single entity, like a government. Governments create their own currencies for official transactions in a centralized monetary system. We often refer to government-backed money as fiat currency. There isn’t something, like gold, backing the currency, so it exists by decree and is considered legal tender. Cryptocurrency, on the other hand, can be used for transactions and to purchase items but is not considered legal tender.
Realize, too, that cryptos aren’t regulated like stocks. When you’re starting in the stock market, even though you know there are risks, you also know there are protections for your money and that companies and exchanges are regulated. This isn’t the case with cryptocurrencies.
However, there is some argument that cryptocurrencies are also a form of fiat money because these currencies exist without anything but the faith of those using them and their value isn’t derived from an underlying asset either. In the end, though, the main features of a cryptocurrency are that it’s digital money and that it’s decentralized and not controlled by a government (though a government could conceivably create its own cryptocurrency).
There are thousands of different cryptocurrencies in existence. However, the most popular cryptocurrencies are those like Bitcoin, Ethereum, Litecoin, Monero, and Ripple. Pretty much anyone can issue a cryptocurrency. The main determinant of success is whether others use your coin as a medium of exchange. As long as you have a way to create your coin and exchange it digitally, you can make a cryptocurrency.
Although not official legal tender, it’s possible to use cryptocurrencies as a medium of exchange. If you perform a service for or buy something from another person, and they accept a cryptocurrency, you can use it as a form of payment. Additionally, it’s recognized to the point that if you invest in cryptocurrencies, and you realize a gain from it, the IRS expects you to pay taxes.
How cryptocurrency works
When learning to understand cryptocurrency as a beginner, it’s good to have a general idea of how it all works.
Cryptocurrency transactions are supported on an open public ledger, which is distributed throughout a network. Each person who participates has a public key and private key designed to identify them. In order to complete a transaction, your key is used to verify the authenticity and specifics of the exchange. It’s an interesting process that allows for privacy (your information is encrypted) while also being transparent and public.
If you have a cryptocurrency wallet, you can send and receive coins and make payments. In recent years, cryptocurrencies have adopted some of the trappings of mainstream banking, including connecting your wallet to a debit card and the ability to exchange your cryptos for legal tender at ATMs.
However, if you want to conduct business with someone who accepts cryptocurrency coins as payment, you can do so simply by accessing your digital wallet and transferring the required payment to someone else’s wallet using the key they provide.
Cryptocurrency is created through a process known as mining. Miners solve complex problems to unlock new currency and new blocks are added to the chain. Because transactions and blocks are verified among peers, this is what allows cryptos to operate without the need for a central bank or authority behind them.
The advantages of cryptocurrency
First of all, it’s important to understand that using cryptos as a medium of exchange versus investment are different situations.
Some people like using a cryptocurrency as a payment method because it allows them to operate outside the central banking system. Additionally, they like the semi-anonymous nature of it that allows them to maintain a degree of privacy. Blockchain verification technology also makes these transactions fairly secure and it can be harder to commit fraud in some cases.
Finally, completing transactions through cryptocurrency can be fast and easy. In some cases, transferring funds via crypto coins can be faster than a wire transfer with a bank — and the transaction fees might even be lower. Plus, with a bank, there are cutoff times (having to make a transfer by noon for a same-day credit) that you don’t see with cryptos.
As an investment, the cryptocurrency market tends to look attractive because there’s a lot of interest in them right now, so the value continues to rise. For example, as of the morning of Sep. 21, 2020, CoinMarketCap reports that Bitcoin has a price of $10,395. If you’d bought a bitcoin or been rewarded one through your mining efforts back in 2014 — back when it’s value was more in the $130 range — you’d be in good shape right now.
Is cryptocurrency a good investment?
First, as a cryptocurrency beginner, it’s important for you to understand how to look at the investment potential. Even though prices have been rising for the most popular and well-known cryptos, it doesn’t mean getting into the crypto market is the best investment for you.
When trying to decide whether you should invest in cryptocurrency, start with how much you can afford to lose. It seems attractive to say that you could make big bucks by investing in something like Bitcoin, but it’s also important to note that new asset classes, like cryptocurrencies, can be volatile. Bitcoin might be worth about $10,000 today, but in 2017, Bitcoin hit an all-time high of right around $20,000. A lot of people took a risk, and if they bought near the peak, their investment has lost value.
As with any investment, it’s important to understand where crypto trading fits in your portfolio. For example, I have Bitcoin, Ethereum, and Litecoin as part of my investment portfolio. However, all of my crypto holdings amount to less than 5% of my total portfolio. My bitcoin is actually something I accepted in payment several years ago, and I’ve bought Ethereum and Litecoin because I think they have potential.
One way to consider cryptocurrencies is to think about what else they can be used for. An example is Ethereum, which has built an infrastructure aimed at smart contracts. The platform could be used for real estate transactions and supply chain management, so it offers other valuable uses than just being a payment system. There are those who now look at Bitcoin as a store of value (an asset that will likely maintain its value, like gold) because the transaction speed has slowed in recent years — and because it’s the most well-known of the cryptos. Litecoin, on the other hand, is often seen as an experimental ground for improvements to the Bitcoin platform and is sometimes seen as silver as compared to Bitcoin’s gold.
When deciding which cryptos to add to your portfolio, consider how you think they might grow in the future, or whether they might be adopted more widely. Some people like Monero right now because it bills itself as a truly private monetary system that will protect your transactions from prying eyes.
As always, though, realize that you could lose money, and you should be careful about committing more money than you can afford to lose. Cryptocurrency can make an interesting addition to your portfolio and add some diversity beyond stocks and bonds, but because it’s a new asset class, consider exercising caution in how much you rely on cryptos in your portfolio.
How to get started trading cryptocurrency
If you decide you want to hold cryptocurrency in your portfolio, it’s relatively easy to get started in crypto trading. Your first step is to get a cryptocurrency wallet or set up an exchange.
There are a number of online wallets available. However, not every wallet supports every cryptocurrency. Research ahead of time to decide which cryptos you’re most interested in. Then, verify that the wallet of your choice supports the use of your crypto. Some popular wallets include Nano X, Trezor Model T, Electrum, and ZenGo.
These wallets are hardware-based and encrypted, which means you can keep your private key safe in an offline environment. It’s important to remember your private key because it’s the only way to access your wallet. If you lose your key, you could also lose all your currency. Using a hardware wallet for your coins is the most secure way to store them, but it can also make accessing them a little more cumbersome.
On the other hand, it’s also possible to set up with an exchange like CoinMarketCap or Coinbase. These operate more like bank accounts, allowing you to log in and buy and sell cryptos, as well as use your account to direct payment elsewhere. However, these software-based solutions might leave you more vulnerable. But if you want to trade coins and invest in cryptos, rather than focus on cryptocurrency as a medium of exchange, it might make sense to use a cryptocurrency exchange.
For ease of trading, I use an exchange. However, I do have an old wallet from the early days, and I can direct my coins from the exchange to my wallet, and vice versa. For storage, it can make sense to have a hardware wallet. Most of my coins, however, are stored in my exchange account for easy use.
Finally, you can also trade cryptocurrencies using some investing apps. Robinhood allows you to buy and sell cryptocurrency, and eToro is another popular platform that offers access to cryptocurrency trading.
FAQs about cryptocurrency
What is an ICO?
When you begin trading cryptocurrency, you’re likely to come across the term ICO. This stands for initial coin offering. An ICO is a chance for you to buy coins when they are first released, just as an IPO indicates the release of a new stock.
Although ICOs can be a way to buy cryptocurrency early on, there’s no guarantee the currency will be widely adopted or profitable down the road. Additionally, ICOs are subject to fraud, according to the Securities and Exchange Commission. In general, it’s important to be very careful when investing in an ICO if you want to avoid scams and not lose your money.
What is the best cryptocurrency exchange for beginners?
There are a number of different exchanges and which is right for you depends on your goals and your personal finance situation. Some of the more popular exchanges you might consider include Coinbase, Cash App, Binance, and Bisq.
Bottom line on cryptocurrency for beginners
Investing in cryptocurrency can be a different way to make money and grow your portfolio. And there’s no denying it can be exciting to trade in a virtual currency versus the regular U.S. dollar. However, it’s important to realize that, as with any investment, you could lose what you put in.
Additionally, cryptos represent a new asset class — one that remains untested through time. Stocks and stock exchanges have been around for hundreds of years, and there’s a reasonable expectation they will continue to be a viable asset class. We’re still waiting to see what happens when it comes to the future of cryptocurrency.
Increased government regulation could change how these currencies operate, and changes in technology could potentially render today’s cutting-edge digital assets obsolete in a few years. Although you can find success in trading cryptocurrency, make sure that it fits into your overall investing strategy, and that you’re careful to maintain appropriate diversity in your portfolio.