If you have been following the cryptocurrency scene over the last couple of years, investing in crypto may seem like a shortcut to the moon or a get-rich-quick scheme, especially with news of Dogecoin millionaires and Shiba Inu billionaires hitting the headlines. But, unfortunately, it’s not that simple.
Understanding how crypto works and its potential risks can be challenging and overwhelming for the average investor. If you are new to the scene, you may not know the best investment strategies and the risks involved. Luckily, we will cover all the basics, so you can have everything you need to know to choose the right cryptocurrency investment strategy for your financial goals.
- Compared to traditional markets, the crypto market is still relatively new. Cryptocurrencies are digital assets that can get used for many different functions, such as purchasing goods and services or building new technologies on top of blockchains.
- Before purchasing any crypto, weigh the benefits against each trade-off thoughtfully and meticulously.
- We will provide an overview of six steps you can take to invest in the crypto space, including researching for informational purposes and earning passive income from hodling crypto.
An Introduction to Crypto
Cryptocurrencies are blockchain-based, digital assets that are relatively new to the investment world. Since its inception, crypto has often been compared to alternative investments like gold and stocks, while some crypto evangelists have even touted the digital currencies as money of the future. Because crypto is so new, there’s not much research on how it can fit into most people’s overall investment strategies.
For one, defining what crypto is and how it operates is not easy. They can serve as an investment, but you can also purchase goods and services using crypto or build new tech on top of their blockchains (Think NFTs and other dApps). In addition, they operate independently from other financial markets, such as real estate and the stock market. But, they are just as hyper-liquid, with the crypto market operating 24/7.
Most investors view crypto as a speculative investment due to its high fees, potentially astronomical returns, and high volatility. Since its inception, Bitcoin’s value has grown more than 10M%! In comparison, the average annual return of the S&P 500 in the past ten years is roughly 13.6%, according to Goldman Sachs data.
Some investors may invest as little as a few dollars or as much as hundreds of millions into the 6,500+ digital assets in circulation today. Despite its reputation as a speculative investment, more recently, there have been talks of Bitcoin futures ETFs getting approved and institutional investors piling money in as part of their long-term investment strategies.
Among those investing, some want to hedge risks, boost overall returns, diversify their portfolios, or combat rising inflation. Much like how they treat mainstream assets, many investors are starting to give crypto their own allocation within their portfolios and regularly rebalance their holdings.
Currently, the only ways to invest in most cryptocurrencies are through direct investments in exchanges, lending platforms, or crypto wallets. If you want to invest indirectly to be safe, consider exchange-traded funds (ETFs), futures options, and crypto proxies like MicroStrategy or GBTC instead.
Before investing in crypto, research the crypto exchanges you are interested in and make sure they are legit. That includes verifying that they are compliant within your jurisdiction, have reputable backers, good customer support, simple withdrawal options, and solid security protocols in place.
Once you have done your research:
- Open an account at your preferred crypto exchange and start with “blue-chip” cryptocurrencies, such as Bitcoin and Ethereum. If you have the means, we recommend spreading your capital across the top-performing platforms rather than putting all your money in one place.
- If you want to be extra safe, consider buying a hardware wallet, such as Ledger or Trezor. Then send the coins you purchased from your exchange to your wallet.
- To earn extra income, stake your coins either on your hard wallet or exchange while you hold them.
- If you decide to use a hard wallet, store it in a safe place and keep the recovery phrase in a separate location.
- When you are ready to take profits, send the coins back to the exchange to cash out. Alternatively, you can use the coins to purchase goods and services in their respective ecosystems.
If you want to invest in crypto, but want to minimize risks of errors on exchanges or hacks, the best option is to keep all your long-term digital assets on a hardware wallet. However, if you choose to do this, make sure to keep your recovery details in a safe place to ensure you do not lose all your crypto.
Benefits and Disadvantages of Investing in the Crypto Market
There are many benefits and disadvantages to investing in the crypto market.
Before investing in crypto, or any assets in general, think about why the investment belongs in your portfolio. Here are a few ways investors today commonly view crypto and its benefits.
Store of Value – Investors believe that blue-chip cryptocurrencies, such as Bitcoin and Ethereum, will grow in value over time. So, they may wish to invest a significant amount of capital into the top runners and hold them indefinitely or make recurring investments over time.
Inflation Hedge – Inflation concerns are growing by the day, particularly after the recent inflation reports for September 2022. Investors concerned about the diminishing value of their local currencies may want to allocate a percentage of their portfolio to digital assets that do not have central authorities to print money as they please.
Risk Management – Some investors use crypto as a way to diversify their holdings and protect themselves from downturns in real estate, bonds, stocks, or other assets. Because crypto is decentralized, governments or major institutions have less power over their distribution and usage. Although, note that whales, or the big moneys, can have an outsized influence on some coins.
Boost Returns – Exposure to cryptocurrencies give investors opportunities to yield life-changing returns. In early January 2021, Solana was worth less than $2 a coin. Now, in October 2022, it’s worth ~$31. That is a ~15x return in less than two years!
In particular, Bitcoin possesses several features that have earned it the nickname “digital gold.” Bitcoin has built-in scarcity, which makes it a highly deflationary currency. There will only be a total supply of 21 million Bitcoin, and once it’s all mined, that is it. Additionally, its strengths include verifiability, portability, and durability. Unlike inflationary fiat currencies, Bitcoin is arguably a much more lucrative asset.
With any investment, the bigger the reward, the bigger the risks. There are several disadvantages to cryptocurrency investing that may be deciding factors in your decision to avoid the digital assets altogether.
Market Volatility – Compared to other financial securities, the value of cryptocurrencies can fluctuate a lot on a day-to-day basis. For example, in May 2021, a crypto crash wiped out roughly $1 trillion in market value in a single week. If you lack investment knowledge or conviction about the future of crypto, it is easy to “paper hands” and sell out at a significant loss during periods of high volatility.
While a volatile market provides great opportunities for experienced traders, retail investors who are risk-averse or new to the crypto space may not be able to stomach it as well. This volatility is one of the main reasons why many financial advisors and planners tell investors to stick to index funds or blue-chip stocks instead.
Lack of Regulation – Because the crypto space is still relatively new and emphasizes decentralization, there are no regulatory structures in place to monitor what happens. Cryptocurrencies are considered their own asset class and are not FDIC insured. While some more reputable exchanges have insurance mechanisms in place, there is a chance that you will lose all your money.
Not Easily Accessible – While some countries are adopting Bitcoin as legal tender (ex. El Salvador), others are making moves to ban crypto (ex. China). Depending on where you are located, it may be extremely difficult or even illegal to purchase crypto. Make sure to check the regulations in your city or country beforehand. Additionally, because there are high fees for buying and selling crypto, that may be a barrier to entry for some investors.
6 Ways to Optimize Your Investments
There are many different strategies you can take to invest in cryptocurrencies. We will cover a few ways to optimize your asset allocation for your unique financial profile.
1. Do Your Research
Before you dive into cryptocurrency investing, make sure to learn about the projects you are interested in, including what their use cases are and how they will affect the way people use tech in the future. Like any other assets you invest in, only invest in securities you understand.
For example, most investors consider Bitcoin a store of value, similar to gold and silver, whereas Ethereum is used to run smart contracts. On the other hand, meme coins like Dogecoin and Shiba Inu get driven by hype and have limited utility. No matter what your financial goals are, always make informed decisions and avoid mindlessly chasing the hype.
In addition to researching the projects, pay close attention to what is happening in the market. Crypto tends to overreact to bad news, celebrity tweets, and hype, which leads to wild price fluctuations. The sources you use to stay on top of current events are also crucial to your success. Scams are rampant in the crypto world, so make sure to follow trusted sources and never give out any personal information to anyone.
Invest Early in Strong Projects
The longer you hold your investments, the more you can earn over time as their value increases, especially if you pick strong projects. To discover new projects, you have several options:
- You can check out ICOs (Initial Coin Offering) platforms such as ICOalert or ICO Bench.
- You can dig through Smith + Crown’s resources, the world’s leading blockchain research group focused on providing educational research on crypto.
- Exchanges, such as Coinbase and Gemini, provide educational resources for free.
- Find reputable crypto leaders on YouTube, Twitter, Patreon, and Discord that help educate investors on the crypto sphere. A couple of my personal favorites are InvestAnswers and Coin Bureau.
Once you have a rough idea of which projects you want to invest in, start evaluating the opportunities at hand to pick the best ones. Consider how unique the projects are, use cases, the team, the whitepaper, community involvement, coin distribution or smart contract guidelines, accessibility, etc.
2. Dollar-Cost Average vs. Lump Sum
There are two approaches you can take when you make your investment.
You can dollar-cost average into crypto by investing at regular intervals. For example, you can invest a certain percentage of your paycheck every week or month. With this approach, you do not have to worry about short-term volatility. That is because you will be adding to your portfolio regardless of whether it is a bull market or a bearish market. The goal is to generate long-term returns by focusing on securities with sound fundamentals.
Or, you can go all in and invest all your available money. For example, if you receive a bonus or win the lottery, you will invest the entire amount available in one go rather than splitting that amount into periodic investments. While lump-sum investing is statistically a better investment strategy in the long run, it is not necessarily the best strategy for you. Consider your risk tolerance and much capital you are willing to invest.
For the past couple of years, I’ve employed a mix of both strategies. When I first started investing in crypto, I made a lump-sum investment into Bitcoin and Ethereum. After that initial investment, I started investing a small percentage of my paycheck every month into those two coins and a few other coins that caught my eye, including Cardano and Solana.
3. Stake Your Coins
If you stake certain coins, such as Ethereum, Polygon, or Polkadot, on your hardware wallet or with an exchange, you can earn a yield while hodling in the meantime. There is a small risk that the exchange may get hacked, but if you stick to credited exchanges, such as Coinbase or Kraken, your risks should get minimized.
For coins that cannot get staked, such as Bitcoin, the alternative is to lend them out and earn interest on them if you want passive income. We recommend using Gemini, which is a leading platform with competitive rates. While you may encounter similar third-party risks, if you spread your money across different platforms and leave part of your crypto on your hardware wallet, that should help mitigate some risks.
Note that lending your crypto can be a highly risky maneuver. Recently, Celsius froze withdrawals and filed bankruptcy, which has had a ripple effect across its userbase. Unfortunately, some of my assets were impacted as well. But, luckily, I spread my crypto across multiple platforms so that helped soften the blow.
5. Only Invest What You Can Afford to Lose
The crypto market is a highly volatile market, so the rule of thumb is to invest the amount you are willing to lose and no more. Do not invest with cash that you will need soon as the time horizon is too short for you to make up for any potential losses. Additionally, do not sacrifice your quality of life and deprive yourself of your daily needs to invest in crypto, as that can lead to irrational decision-making and emotional rollercoasters.
Before you get into cryptocurrency investing, other financial vehicles you should have include an emergency fund, retirement accounts, and individual brokerage accounts. Despite all the stories you may hear of crypto millionaires and billionaires, there are no guarantees that your crypto investments will go to the moon.
The fallout of the TerraUSD stablecoin and its sister token Luna, back in May 2022 had a ripple effect across the entire crypto space. In a matter of days, tens of billions of dollars in value was wiped out and both coins became practically useless. The fallout served as a reminder of how risky crypto can be. We recommend remaining realistic about potential returns and avoid investing more than you can handle.
6. HODL (Hold On For Dear Life)
Hodling is a long-term strategy that is one of the most effective ways to build wealth. This strategy is simple. Once you buy your crypto, you hold and wait for their value to rise. For most investors, seeing a 300x gain in a month is highly unlikely (though not impossible). The investors who have hundreds of millions or billions in crypto are more likely than not to be people who have held onto them for years.
Compared to day trading, building your wealth slowly and steadily over time is a much better approach. While this strategy may not be as sophisticated as you’d expect, history has shown that a long-term approach is the best strategy for the average investor.
My Crypto Investment Approach
I use the dollar-cost averaging method and invest roughly ~10% of my paychecks every month in crypto, though I made a one-time lump sum initial investment when I first started. Because I am still learning new things about the space every day and have limited capital, my current strategy is to invest in the top runners and avoid everything else. I also have some capital in stablecoin (GUSD) and treat it as a high-yield savings account (HYSA) (though it doesn’t replace my actual HYSA).
Though the amount I have invested is higher than the recommended 5% by most financial advisors, I am very bullish on the cryptocurrency market. My risk tolerance is fairly high because I focus on capital growth rather than wealth preservation. To mitigate risk, I also spread my money across multiple exchanges and platforms, including Coinbase and Coinbase Pro, Gemini, and BlockFi. That way, if something happens to one platform, I will not lose everything.
As I mentioned earlier, InvestAnswers is one of my favorite crypto experts, so I watch his videos every week to hear the latest crypto news and his research on different tokens. What I appreciate about him is that he provides thoughtful analysis and avoids pump-and-dump schemes. Additionally, I read up on the financial and economic news every day, set up alerts on my phone for drastic price action, and have the charts open on my laptop 24/7 (though I will admit this last part is a bit extra).
The Bottom Line
Generally speaking, investing in the cryptocurrency market poses more risk than most alternative securities. However, crypto investing can serve as a way for investors to diversify their portfolios and increase their chances of higher returns over time.
Everyone will have a different investment approach. Before you start, developing healthy investing habits and understanding the trade-off of investing in the crypto market versus traditional markets are crucial. That includes understanding what you are investing in, learning about various investment styles, and taking note of your risk tolerance.