What is Cryptocurrency?
Cryptocurrency, more commonly known as crypto, is a digital asset that can be bought, sold and circulated without the intervention of a central monetary authority like a bank or the government. Instead of a central authority, crypto is created using a technique called cryptography which allows people to sell or buy or trade them in a secure way,
Bitcoin and the majority of other cryptos are built on top of what is called blockchain. The blockchain creates a tamper-proof record of all transactions and records who owns which cryptocurrency. In the past, there have been structural issues when trying to create digital currencies because it wasn’t built on top of a blockchain. This meant that it could be tampered with and people could make copies of what they owned and try to spend them twice or more.
An individual unit of cryptocurrency is referred to as a token or a coin depending on how you use them. Some are used as a unit of exchange like a fiat currency and are transferred for services or goods. Others are used as a central store of value. The third type is mostly used to help run computer networks to compute complicated financial transactions.
You might have heard of the term mining – this is a common way that cryptocurrencies are created. Bitcoin uses this process. Mining is an incredibly energy-intensive process where computers have to solve a series of complex puzzles and calculations in order to verify the data that is stored on the network. As a reward for solving these puzzles the owner is rewarded with newly created crypto. There are other ways that cryptocurrencies are created and distributed and not all of them have such a huge impact on the environment.
How Can I Buy Cryptocurrency in a Safe Way?
There are a number of different ways to buy cryptocurrency safely and the method that most people choose is to use a centralized exchange to buy their crypto. Centralized exchanges act as a third-party intermediary to give buyers and sellers confidence that they are getting what they paid for. A typical exchange will sell Bitcoin at the market rate and will make their money through fees for various aspects of the services they provide.
If you feel more comfortable working with a traditional brokerage then there are a couple of online brokers that offer access to not only stocks but also cryptocurrency. Some of these include Robin Hood, SoFi Active Investing, Trade Station, and Weebull. If you’d rather deal with an exchange that just works in the digital world, then you should search for purely crypto exchanges. The most popular of which is Coinbase but also Kraken and Gemini are on the list. The only challenge with these exchanges is that you’ll only be able to deal crypto and not traditional assets like bonds or stocks. On the plus side, they generally have a better selection of cryptocurrencies and offer better on-platform storage solutions.
Centralized exchanges are easy to use, but this also means that they could be an attractive target for hackers because of the amount and volume of cryptocurrency that flows through them every day.
If you’re a more advanced user, there are decentralized exchanges that offer lower fees than a centralized exchange. They are more technically complicated to use but might also offer higher security benefits because there is no single point of entry or access for a hacker using a cyber attack. You can also directly trade crypto through peer-to-peer transactions with someone that you know.
Choose How You’ll Pay for Your Cryptocurrency
At time of writing there were thousands of cryptocurrencies being traded globally. In most centralized exchanges, they’re mostly available to purchase by using normal money, or what is called a Fiat currency. A Fiat currency is a government-backed currency like the US dollar or the British pound. If this is the first time that you’ve bought crypto, then you’re very likely to have to use a regular Fiat currency to buy crypto for the first time.
Once you’ve traded crypto for a while, you might be able to use your own cryptocurrencies to buy other currencies like Ethereum or Bitcoin.
Add Money to Your Accounts
Depending on what you chose in the last step you might have had to fund your online account before purchasing your first cryptocurrency. If you did use a fiat currency then most online exchanges allow bank transfers or debit transfers. If you want you can also use a credit card but this can be very risky. Digital currencies are incredibly volatile assets and if you combine this with interest rates on a credit card then if the value of crypto goes down, and you can’t repay your credit card bill, then you could be in trouble.
If you already own cryptocurrency from another centralized or decentralized source then you can transfer it to your account from your digital wallet or another platform, then you can use it to buy other currencies. Before you do this make sure that the exchange you are moving to allows trading between the two assets that you want to trade – e.g. from Bitcoin to Ethereum or from Ethereum to Dogecoin.
One last thing you should look at is the fees that the exchange will cost. Fees will differ depending on which exchange you use, and what you are buying and selling. Make sure to look at this very closely before buying anything so that you’re not in for a surprise.
Select the Cryptocurrency You Want to Buy
There are a number of options if you are investing in cryptocurrency and because there are so many options, there won’t be one that is right for everyone. Before you decide to buy anything you should ask yourself what your goals are for this investment are. Do you want to make money through an increase in value? Do you want to use it to undertake other transactions using crypto? Are you fascinated by the technology that underpins these centralized apps? If you ask yourself these questions before you start it can help you with your decision.
Some of the most popular cryptocurrencies include:
- Bitcoin – it was the first and is currently the most valuable crypto.
- Cardano – a competitor to Ethereum which was created by one of it’s co-founders.
- Ethereum – most commonly used for financial transactions that are more complex then Bitcoin can handle
- Litecoin – like a Bitcoin lite which was set up to make payments easier and faster.
- Solan – another Ethereum competitor that puts a focus on cost-effectiveness and speed
- Dogecoin – the crypto world’s biggest joke until it wasn’t. It is now one of the most valuable cryptocurrencies
- Stablecoins – a grouping or class of cryptocurrencies whose values are designed to be pegged to real-world assets like the USD.
Best Cryptocurrencies by Size of Market Cap
At the time of writing, there were more than 19,000 cryptocurrencies publicly-traded according to CoinMarketCap.com (a website that does market research). This is a huge number and on May 18, 2022, there was a total market cap of $1.28 trillion which is down from an all-time high market cap of almost $3 trillion in late 2021.
How do I Keep my Cryptocurrency Safe?
Earlier in this guide, we talked about how centralized exchanges can be a target for hackers and so now we will cover why it is important to pay close attention to security after you have bought your crypto. After you have bought your crypto the next step will be how to keep it safe and secure.
After choosing why and how to invest in crypto, keeping it secure is right up there in importance. Any crypto-asset requires a private key that proves your ownership of that specific asset and is non-negotiable when carrying out a transaction. If for some reason you lose your private key then your crypto is gone. If someone gets access to your personal private key then they can use, spend or trade your crypto however they want to. In this way it is like a bearer bond – if you have it you own it.
To store your crypto securely you can use a digital wallet to keep your holding secure. When choosing a digital wallet there are multiple options to consider.
Non-Custodial Wallets – There is always a threat of hacking when using on-platform storage (see below) and this means that it is very risky to leave large balances of any cryptocurrency on an exchange for a longer period than absolutely necessary. If you want to look into storing your own crypto locally then there are many options on the market. When looking at these options there are two separate options – hot wallets and cold wallets. Cold wallets are offline on a physical device (USB or hard drive) that are physically impossible to get to unless you take control of that physical device. A hot wallet has a certain amount of online connectivity which makes them easier to use day-today but could expose you to security vulnerabilities. It is important to think carefully about hot vs cold and in some cases, you might store your crypto across multiple places to reduce the risk of losing it in any one specific way.
On-Platform Storage – Many choose to keep the cryptocurrency that they buy on the platform or exchange that they buy it. This does have some advantages and is generally easier for the user/consumer. The main thing it does is outsource the complexity and complications to an experienced third party that usually brings more experience to the table. You don’t need to keep close track of your own private keys (although you should have them written down somewhere) and all of your information is at your fingertips when you log in to the platform. The downside is that if the exchange has a hack and gets your own individual credentials then your crypto could definitely be at risk. Generally on-platform storage is used by those who think that they will trade, buy, or sell their crypto in the short term and so want easy access to it quickly.
What are the Pros and Cons of Owning Cryptocurrency?
You don’t have to look far to find people arguing and promoting the benefits and drawbacks of crypto in an incredibly passionate way. Many believe that it will change the world with its technology and some believe it is a passing trend.
The Pros of Cryptocurrency
- Many supporters of Bitcoin like that there are no central governments or banks involved in managing the money supply. They argue that banks tend to reduce the value of fiat currencies over the long run due to inflation.
- Supporters view crypto such as Ethereum and Bitcoin as currencies of the future and want to buy them now and speculate that they will become more valuable over the coming years and decades.
- Especially in those communities that have been underserved by the traditional financial system (banks, credit unions) they see crypto as a way to get into the new financial system. Data shows that Black, Asian and Hispanic people are more likely than “White adults to invest in, trade or use a cryptocurrency”. Pew Research.
- There are speculators that like crypto because they have gone up in value and don’t have any interest in it being accepted as a currency.
- Many like the underlying technology, the blockchain and argue that cryptos are a good way to get consumers comfortable with the idea of using a decentralized system that can be used for other things.
The Drawbacks of Cryptocurrency
- Lots of cryptocurrency projects are untested and have been created due to the hype surrounding other coins. It has been easy to get people on the bandwagon of a new coin as they’ve seen the success of other random coins like Dogecoin.
- Blockchain technology has not yet gained widespread acceptance and adoption and so still remains a bit of a mystery to many people. If the idea of blockchain technology is never widely accepted then crypto may never realize its long-term potential and returns that investors are hoping for.
- Many crypto investors have been lured by the idea of quick money and cash and while some have made quick money, many have bought into the buzz and have lost money because they bought right before a crash. It’s a risky strategy to buy crypto to make quick money.
- Huge fluctuations in value reduce credibility as a stable long-term payment method. If you can lose 40% of the value of your coin overnight, you will not want to hold on to it to use it to buy groceries and utilities as you’d be concerned that you wouldn’t be able to afford it one day to the next. Especially if the item you’re buying is priced using a fiat currency – the fiat currency won’t lose its value, but you will lose the value of your crypto.
- The environmental impact is something that many naysayers of bitcoin bring up constantly. The amount of energy that mining bitcoin uses is significant. One study showed that bitcoin mining globally takes more than double the power it takes for all lighting in residences in the US. Other crypto currencies use technology that uses less energy but it is still significant.
- Government oversight is something else that could cause crypto to have issues over the long run. Governments around the world haven’t quite figured out how to regulate crypto and in the past you have seen regulation in one country (or the banning of bitcoin mining in China) cause huge drops in value for crypto overnight.
How Can I Manage the Risk of Cryptocurrency?
No matter which way you look at it, buying cryptocurrency is a risky investment. If you look at a balanced investment portfolio then the general rule of thumb is to have only 10% of high-risk investments. 10% is an absolute maximum and most experts suggest that not all of it should be held in crypto. Before you invest in a risky asset like crypto you should look to invest money in other places – make sure that your 401k is topped up, and you’ve paid off outstanding student or credit card debt. Once that is done you should then look to invest in some electronically traded funds (EFFs) before looking at stocks and bonds.
When you look at your crypto portfolio (which will be risky) you should try to diversify within it. For example – if 8% of your total investment portfolio is in cryptocurrency – you should look to diversity within that 8%. E.g. 1% of your portfolio could be Bitcoin, 1% Ethereum, 1% Solano etc. until you have made up that 8%. In this way, you are diversified within a very risky investment class. It is worth keeping in mind that many cryptos rise and fall together and sometimes are swayed by Bitcoin’s rise and fall.
Before you invest in crypto you should do your homework and background research. This is true for any type of investment but is doubly true with crypto. When you buy a stock or bond it is linked to a government or specific company, when you buy crypto it is linked to the technology that it is built on. In many cases the technology that it is built on is untested and unregulated and so you’re never quite sure what you’re buying. When buying a stock on the stock market you know the company has been scrutinized by investors and financial institutions and so mostly is valued correctly.
Crypto is loosely regulated in the US and so figuring out which products are a good investment can be very difficult. The most widely traded and invested in cryptos have publicly available metrics which include transaction volume and growth in users. These metrics can be helpful in deciding where to invest.
If you do want to invest outside of the well-known cryptos (see our list by market cap above) then you should ask yourself some key questions.
- Can you afford to lose this money if the project goes bankrupt?
- Who is heading this project – have they co-developed a coin in the past or is it their first time?
- Who are some other big investors – what is their track record in the crypto space?
- Are you investing in the business or are you just getting currency or tokens? This is an important distinction because if you are an owner (like buying shares in a company) then you get a portion of any earnings. If you just get tokens it means you can use them like any other crypto. Being an owner is best.
- Has the currency already been developed or are they looking to raise money to then build it? If the currency is already created then it is less risky. Look to see what evidence already exists about the validity of the currency before investing.
Even if you answer all these questions there is still no guarantee that the currency will succeed. A general rule of thumb is that the more the prospectus is built out, the more legitimate the company is. However, even the most legitimate-looking companies have failed in the past and so there is no sure way to tell.
Tax and Legal Issues for Cryptocurrencies
Cryptocurrencies are 100% legal in the United States. China has pretty much banned their use and depending on which country you’re in depends on whether they’re legal or not. However – whether they’re legal or not is just one part of the equation. The other thing to consider is whether crypto is taxed and what you can actually legally buy with crypto.
Legal Tender – they’re colloquially known as cryptocurrency but they differ from fiat or traditional currencies in one main way – they don’t have to be legally accepted as tender. If you look at the US dollar – it has to be accepted for all debts, private and public. Different countries are taking different approaches.
Taxes on Crypto – Again, the word currency is not entirely accurate when it comes to taxes in the US. In the United States, cryptocurrencies are considered property, rather than currency. This means that when they’re sold you have to pay capital gains on them. Capital gains are calculated as the difference between what you paid and sold them for.