Cryptocurrencies are now the hottest asset class in the marketplace and the recent influx of crypto-based investment funds only further testifies to this truth. With hundreds of new altcoins popping up in the market as a result of billions in investor funding, traders see a new world of opportunity in the digital token boom despite bitcoin’s continuing decline in price.
Just the other day, the Silicon Valley-based investment firm Andreessen Horowitz announced a $300 million fund dedicated to investing in blockchain projects as well as the various currencies themselves. Crypto exchange Binance has already made it known that it was planning a $1 billion dollar crypto-fund themselves. As blockchain technology continues to become more popular, the potential profit opportunities for investing in this area are staggering.
At the same time, investing in the cryptocurrency world is changing. The last vestiges of the unregulated, “wild-west” atmosphere that existed during the early ICO’s up until the boom in 2017 is fading away. Instead, the industry is facing a future where increased regulation, growing adoption rates, as well as mainstream acceptance will cause an irreversible maturation in the industry.
What that means for investors today is that there has never been a better time to jump into the crypto investing world than now. Here are a few considerations to keep in mind when getting started.
Good and Bad Reasons To Invest
It’s worth mentioning that there are many good reasons to start investing in cryptocurrencies. Whether that might be hedging your net worth from fiat collapses, supporting the social vision and technology behind a project, or even just the pursuit for profitable returns are all valid reasons why to start investing. However, there are many reasons why you should not get involved in the area.
For some, that might be falling victim to the hype that surrounds the market. In other cases, this can come in the form of a fear of missing out, worrying that you’re missing out on an opportunity that may never come again. While getting excited about the markets potential as well as seizing opportunities aren’t bad things in an of themselves, they need to be undergirded by genuine research and knowledge rather than just emotion.
Understanding the Markets
Before you even consider wallets, exchanges, or any potential software, it’s imperative to have a solid understanding of not just blockchain technology, but how the cryptocurrency markets operate and move. There are significant differences that characterize this specific area that isn’t an issue in more traditional financial markets like stocks, bonds, and derivatives.
For one, it’s important to understand the underlying technology and monetary rules behind whichever token you want to invest or trade in. Some currencies, such as bitcoin, are decentralized. Others are more centralized, which his largely due to the varying consensus algorithms in existence (which you can read more about in a previous article we wrote on the subject here). Closely related is the issue of mineability, with some tokens not being able to be mined. Ripple, NXT, Waves, and others are examples of these and have all their tokens controlled by a single company.
It’s also essential to understand what the business use behind each token you wish to invest in is. In some cases, such as bitcoin, the token serves as a store of value and a method of payment between different parties. Ethereum, on the other hand, is used more as a platform for creating decentralizes applications and autonomous smart contracts. These differences mean a lot in understanding the future potential of an asset.
From then on, specifics such as how many developers are on a project, how large it’s community is, average trading volume (liquidity), market capitalization are all things to consider. When evaluating specific altcoin fundamentals, the process is similar to analyzing an ICO. Look for a transparent technical vision with an active, visible management team. Poor projects are the opposite and tout fuzzy technical promises without expounding on the details.
Know Your Risk Tolerance Level
As is the case with all investments, underlying what level of risk is acceptable to you directly determines which cryptocurrencies you would do best investing in. Of course, digital assets in general have a higher baseline level of risk, partially because the market is still unregulated but also because of other things (volatility and liquidity risks, etc.). Newer currencies are usually available at quite cheap prices, but while they bring a big potential for returns, are also more likely to fizzle out. Mainstream currencies are less likely to see rapid changes in their price level, instead move at slower rates (although as seen in the case of Bitcoin, a mainstream token can still lose most of its value over several months).
To compare the cryptocurrency investing world with regular financial markets, mainstream coins such as Bitcoin can be considered the large-cap stocks of the market. Alt-coins can be compared to the various small-cap and mid-cap stocks with moderate potential for growth. As for ICO’s, the closest equivalent in terms of risk/reward profile would be penny stocks.
For more active traders, the cryptocurrency market is still young enough that significant arbitrage opportunities still exist. Unlike traditional markets, the lack of large, institutional traders with advanced computing software means that price discrepancies are still a (relatively) risk-free method of making money). Feel free to read more about the subject here.
The Basics Behind Setting Up Your Account
As for the actual mechanics behind trading and setting up your account, there are two things that you will need to do. Firstly, set up a digital wallet, and secondly, picking an exchange.
Digital Wallets is what will store all incoming and outgoing information relating to your cryptocurrency holdings. You will need to decide whether to store your wallet online through a website or platform (called a hot wallet), which tends to be simpler to access, or instead use a USB stick or hard drive (a cold wallet). The latter method is more secure from hacks but also makes it harder to use, especially for beginners).
If you wish to invest in lesser-known cryptocurrencies, you will also need to make sure that your digital wallet in question can store those specific tokens, as some online wallets don’t accept all types of altcoins.
The next question is to pick which exchange you wish to use. While there are hundreds of exchanges out on the marketplace, some of the more notable ones include bittrex.com, gdax.com, coinbase.com, Binance.com, and others. It’s important to remember that not only do exchanges have different fee structures, but some (such as Bitfinex and Coincheck) have been hacked before. Always keep your cryptocurrencies stored safely in your wallet, rather than in an exchange, no matter how secure they may market themselves to be.
Within the financial world, investors tend to fall within two schools of investing thought, fundamental and technical analysis. A fundamental approach would be more focused on the intrinsic aspects of a company or venture, including its balance sheet, evaluating its market potential, earnings ratio, debt levels, and other aspects to find whether it’s undervalued or overvalued at the market price. Technical analysis puts all of that to the side and instead focuses on forecasting future price movements by looking at past behavior of markets, chart patterns, and historical trends.
While the precise application of these two competing approaches isn’t the topic of this article, it’s worth mentioning that while fundamental analysis tends to apply to a long-term approach to investing, technical analysis is more proponent amongst short-term traders, speculators and the like.
A Hypothetical “Balanced” Portfolio
As for the actual distribution of your funds, much of this depends on what your earlier mentioned risk levels are as well as the amount of time you’re willing to put into investing. For someone that’s still unsure of what kind of approach they’re looking for, a balanced, diversified portfolio distributed between a variety of cryptocurrency asset types is recommended.
In such a case, 60-70% of one’s portfolio can be invested in mainstream tokens, such as Ethereum, Litecoin, Bitcoin Cash, and others for stability. An argument can be made not to include Bitcoin in this list since it’s price has dropped significantly, although others will argue that this low price is a great time to pick up on a deal.
From there, 10-20% of your portfolio can be distributed to other altcoins, along with 5-10% going to any exciting ICO’s going on in the marketplace. Even if only one or two of your ICO’s become successful, the idea is that the return from their successes will make up for the rest of the projects that fell under, similar to how venture capital funds operate. Since this will be the riskiest part of your portfolio, it’s important to allocate to much of your funds in this area.
However you want to distribute your portfolio is up to you, but regardless of your confidence levels, there are some important things to keep in mind. For one, never invest more than you are willing to lose. Secondly, keeping your portfolio diversified will ensure that one mistake or poor decision won’t ruin you. Lastly, never take anything for granted, whether it’s that cryptocurrencies will always be popular or that a token today will continue to exist in the future. With a cautious, albeit well-researched, approach, investing in the cryptocurrency field should be a fruitful opportunity for many.
Also published on Medium.