Cryptocurrency – Introduction to investing in Bitcoin, Ethereum, Ripple & Co.

What investors need to know about cryptocurrency investments and blockchain technology

Cryptocurrency Investor
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Cryptocurrency markets experienced a brutal bear market in 2018 but are now showing signs of a recovery. This is prompting many investors who missed out on the initial bull market to consider investing. This introduction to cryptocurrency markets will give anyone who wants to start investing an overview of the market, the different ways to invest and how to get started with investing in Bitcoin and other cryptocurrencies.

What are cryptocurrencies?

Bitcoin
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Cryptocurrencies are digital currencies that exist on decentralized databases or ledgers. They are not controlled by a central authority in the way that conventional currencies are controlled by central banks.

The decentralized ledgers most commonly take the form of a blockchain. These blockchains act as peer to peer networks and allow anyone to transact directly with anyone else. Blockchains are maintained by miners and all transactions are approved by the majority consensus of all the miners.

The first cryptocurrency, Bitcoin (BTC), was based on a whitepaper published by a person or group under the pseudonym Satoshi Nakamoto. Since then thousands of cryptocurrencies known as alt coins have been created.

Types of cryptocurrencies

Cryptocurrency Coins
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Bitcoin was created to act as both a store of value and a medium of exchange, much like conventional currencies. Since then new virtual currencies have been created with specific purposes and to solve specific problems.

  • Medium of exchange coins are intended primarily to be used to transfer value between two parties. They can be used to make purchases, pay bills or send money to anyone, anywhere in the world. While Bitcoin is most commonly used for this purpose, Bitcoin Cash (BCH) and Litecoin (LTC) are specifically designed for fast, secure, low costs transactions. Ripple (XRP) is designed to allow financial institutions to transfer value quickly at a far lower cost than the banking system currently allows.
  • Platform tokens are used to access a blockchain that does more than just storing a ledger of transactions. The Ethereum (ETH) network, EOS and Waves are networks that act as supercomputers. These networks allow decentralised organisations (DAOs) to operate securely in them.
  • ICO (initial coin offering) tokens are used to transact on DAOs or Dapps (decentralised applications). These platforms exist as marketplaces for goods and services. Funding for these platforms is raised by selling tokens in an ICO.
  • Asset backed tokens and securitized tokens are tokens that are backed by traditional assets like stocks, bonds or commodities. They bring traditional assets to the blockchain, enabling cheap secure transactions to be made.

How does investing in cryptocurrencies work?

Bitcoin Trading
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Cryptocurrencies are best compared to a commodity, rather than a stock or bond. Companies earn profits which accrue to shareholders, and also pay dividends. Bonds on the other hand are tradable loans which pay interest. In the case of cryptocurrencies, their long-term value is based on scarcity and the fact that they have a finite or limited supply. As more people invest in a coin, or buy the coin to transact on a network, demand increases and the price rises. In the short to medium term, the price of crypto assets is driven by sentiment about the future demand for a coin. This makes cryptocurrencies speculative investments.

Cryptocurrencies also differ from other assets in the way they are traded and stored. While traditional assets are traded through a broker on centralized exchanges, anyone can open an account directly with a cryptocurrency exchange. Cryptocurrency trades are recorded directly on the blockchain, where each users balance is also recorded. Each user has an address known as a public key, which they can access using a password, known as a private key.

How to buy and sell cryptocurrencies

Buy / Sell Cryptocurrencies
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Cryptocurrencies can actually be bought and sold directly between two parties. However, it is a lot easier to trade on cryptocurrency exchanges which allow buyers and sellers to find one another and make live coin prices are available. CoinMarketCap lists over 2,000 cryptocurrencies along with their latest price, which is a volume weighted average sourced from over 100 exchanges. The site ranks all the coins by their total market value and also shows the 24-hour volume for each coin. If you click on a price or ticker you will be taken to a page that lists all the exchanges where that coin is traded, along with the different currencies it can be traded for.

Buying Bitcoin is very easy as nearly every exchange lists it. Most exchanges also offer trading in Ethereum, Bitcoin Cash, and Litecoin. For other cryptocurrencies you may have to look around to find an exchange. It’s best to choose the larger exchanges with a good track record. Some exchanges do not accept fiat currencies, which means they are not ideal for making your first purchase. Coinbase is a very popular Bitcoin exchange which accepts fiat deposits, although strictly speaking it is a broker rather than an exchange. That makes it a little more expensive, but it does have a good reputation. Other similar exchanges are Luno, Bitpanda and Kraken.

Once you find an exchange, you need to first check that you can trade on it based on your location. Next you need to check that you can fund an account with your currency of choice and your chosen funding method. If all is in order, opening an account is very easy and takes a few minutes. You will then be required to verify your identity, after which you can fund your account. Most exchanges accept deposits via wire transfer and credit card. In some cases, there are some restrictions on the amount you can invest using a credit card deposit.

Once you have funded an account, buying and selling cryptocurrencies is very easy and the user interfaces are generally intuitive. Before making a transaction, you should always check the market price on CoinMarketCap to check that the price you are being quoted is close to the average market price. The prices of cryptocurrencies do vary from one exchange to the next, but you should always be trading at a price close to the average.

Ways to store cryptocurrencies

Digital Wallet / Cryptocurrency
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With traditional currencies and other assets, the security of your account is the responsibility of your bank or stockbroker. With cryptocurrencies the ultimate responsibility is with you. Bank account deposits are also insured, and a company’s share register means shares cannot be stolen from you.

Because cryptocurrency transactions are anonymous and a blockchain cannot be amended, if a hacker steals your virtual currency they cannot be traced or returned. Cryptocurrency exchanges keep client assets in a bulk wallet. These wallets have been hacked and cleaned out, though to date the exchanges have reimbursed their customers. Nevertheless, if you have a substantial crypto investment it’s best to store it away from the exchange.

You can keep crypto assets securely in a software wallet or a hardware wallet. Software wallets are encrypted applications kept on a computer or mobile device. Each wallet has a public key which is the address you send your coins to, and a private key which is required to access the wallet and send coins from it. Software wallets can be backed up, and a recovery phrase can be used to access them if you lose the key. If you lose both the key and the recovery phrase you will not be able to access the wallet. Popular software wallets include Electrum, Exodus and Jaxx. Not all cryptocurrency wallets can be used for all cryptocurrencies, so this something to check before using one.

Hardware wallets look like a USB flash drive and work in conjunction with a piece of software on a PC. They are a little like a physical key which needs to be used in conjunction with the private and public keys to access a wallet. This makes it absolutely impossible for a hacker to access a wallet, even if they have the private key. The most popular hardware wallets are the Ledger Nano S and the Trezor wallet.

How to invest in cryptocurrencies

Bitcoin Investment
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There are several ways to invest in cryptocurrencies and profit from them. These are some of the alternatives to consider:

  • Buy and hold investing is the most basic strategy. If you believe a cryptocurrency has value, or will grow in value, you can buy and hold for the long term. As crypto markets are very volatile, you are likely to see large swings in the value of your investment – but if you are correct it will pay off in the long term.
  • Cryptocurrency trading can be very profitable given their volatility. Most crypto traders use technical analysis to make trading decisions and hold positions for anywhere from 30-minutes to several months. Trading does take some time to learn but can be a lucrative way to participate in the market.
  • Cryptocurrency mining is a very different way to profit from cryptocurrencies. Miners use powerful computing hardware to maintain the network and verify transactions. They compete for mining rewards which means the income stream can be lumpy. The profitability of mining depends on the price of the cryptocurrency being mined, as miners have high overheads and setup costs.
  • Cloud mining pools are large mining operations that anyone can invest in to share the mining rewards. The minimum investment is as low as $50 which is a lot lower than the cost of setting up a standalone operation. Mining pools also allow investors to spread their investment across multiple cryptocurrencies. Genesis mining and Hashflare are some of the biggest cloud miners. As with all things crypto its important to verify the reputation of a mining platform before investing.
  • Cryptocurrency funds are managed by professional investors and allow investors to spread their investment across multiple currencies. Some of these funds take the form of private equity funds, some are exchange traded funds (ETFs) and some are themselves on blockchains.
  • Cryptocurrency stocks are listed shares in companies that operate in the blockchain industry. They trade on the stock market like any other share meaning they can be traded with a normal stock trading account. Most only earn a portion of their revenue from the industry, though some, specialise in crypto related services. Several ETFs that invest in these stocks have also been launched.

How do you earn from cryptocurrency investments?

Bitcoin Price Chart
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Investors need to take a long-term view when investing in cryptocurrencies. The market capitalization of the entire crypto market is now at $240 billion which is 70% lower than it was in January 2018. On the other hand, investors who bought Bitcoin just three years ago have seen gains of nearly 2000%. Other cryptocurrencies have seen even bigger gains, while most of those that launched in early 2018 are below their ICO price. Those type of gains may be unrealistic for the coins with higher market caps in the future. It is however entirely possible that smaller coins could generate similar returns, although those investments would come with higher risk.

What are the associated fees of investing in cryptocurrencies?

The cost of trading crypto assets directly on a blockchain are very low – much lower than for trading traditional assets. However, commission charged by exchanges and brokers vary and can be as high as 5% in some cases. In most cases retail investors can expect to pay around 1 to 2% to trade smaller amounts. Some brokers charge fairly modest commissions but charge as much as 5% for credit card withdrawals. Investors should check the commission rate and any premium that is being added onto the price paid before opening an account. Active traders tend to trade on digital exchanges that don’t accept fiat as these exchanges have lower commission rates.

Pros and cons of cryptocurrency investments

There are pros and cons to investing in cryptocurrencies. This applies to other asset classes as well, like stocks, bonds, precious metals or innovative Big Data and A.I. based vehicles like our Data Intelligence Fund. In the following we’ve listed the main advantages and disadvantages of cryptocurrency investments.

Advantages

Currencies / Trend
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  • The cryptocurrency market is still very young and there is opportunity for massive gains. Although the crypto market is already worth over $200 billion, this is small when compared to the total value of gold, listed stocks or alternative currencies.
  • Unlike conventional currencies, cryptocurrencies have a limited or finite supply. This means their value will not be eroded by inflation like other currencies or by dilution like stocks.
  • Cryptocurrencies and the blockchains they operate on are a lot more transparent than conventional money markets.
  • Blockchains are immutable, permission-less and censorship resistant. That means they cannot be altered or co-opted by governments or corporations and no one can be barred from transacting on a blockchain.
  • Blockchain technology allows new types of businesses to exist.  Problems that could not be effectively solved by conventional businesses can now be solved by blockchain technology. A new economy is emerging, and cryptocurrencies are a crucial part of that economy.

Disadvantages and risks

Bitcoin / Gold / Cryptocurrency
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  • The prices of cryptocurrencies are very volatile, and they should still be considered a high-risk investment.
  • New regulations have slowed the progress of several types of crypto investments, including ICOs and ETFs.
  • As cryptocurrencies can potentially be used for money laundering, tax evasion and illegal trade, there is a chance government may crack down on them at some stage. This adds a level of uncertainty to the future of cryptocurrency markets.
  • The large amounts of crypto coins being held at exchanges has made exchanges a target for hackers. To keep cryptocurrencies safe, it is best to store them in your own software or hardware wallet.
  • The crypto industry has attracted numerous scam artists eager to take advantage of unsuspecting investors. Investors need to be vigilant and double check the legitimacy of any crypto related investment.

Conclusion: Investing in Bitcoin and other cryptocurrencies

Cryptocurrencies may still be considered as speculative investments, but they also present the possibility of massive returns. The amount of investment that has already been made into the industry means that new innovations are almost certain, and a new type of economy is likely to emerge. At the very least this is an asset class worth learning about, though investors should be cautious and avoid taking on too much risk.

About Richard Bowman
Richard Bowman is a writer at Catana Capital, analyst and investor based in Cape Town, South Africa. He has over 18 years’ experience in asset management, stockbroking, financial media and systematic trading. Richard combines fundamental, quantitative and technical analysis with a dash of common sense.

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