Cryptocurrencies are virtual or digital assets that can be used to purchase goods and services or represent the value of an asset. Like Forex trading, where currencies can be paired against each other to represent fluctuations in value between currencies, cryptocurrencies can be purchased and invested in. If you haven’t already checked out our blog on the fundamentals of Blockchain & Cryptocurrency, you can do so here.
In this week’s blog we discuss how to invest in cryptocurrencies, what the different options are and what the main benefits and challenges are for investors in this space. We will also provide a breakdown of a few cryptos to keep an eye on in 2021, with different levels of risk and possible return.
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Cryptos represent a digital currency built on the blockchain, which is a completely decentralised and immutable database. What this means is that there is no central authority – like a Government in control over the system, and being immutable means that information cannot be edited once created, maintaining its integrity. Soon after the appearance of Bitcoin, alternative coins (ALTCOINS) began to surface, which are issued on their own blockchains.
Tokens, unlike coins are not based on their own blockchain, but are built on top of another, such as Ethereum or Tron for example. They represent company shares and can be thought of as an internal currency. This raises the first major difference when investing in ‘Crypto’, whether you invest in the currency or the token. Investing in a cryptocurrency can be thought of as investing in the success of blockchain as a whole – the entirety of the company operations using that blockchain. However, the token investments are focussed on the success of a single project. This makes investing in tokens a riskier activity, as projects can succeed or fail irrespective of the overall success of an organisation, however the potential gains are much higher. As we will discuss later it is critical to understand what you are investing in and how that investment can benefit you. What needs to go right and what can go wrong that will determine whether it is a worthwhile investment.
On the face of it, cryptocurrencies, tokens, and traditional stocks behave in a similar way, so investing in them should be a similar process. However, there are some subtle differences to be aware of, which you should help you determine which avenue to go down and how much you are prepared to spend.
Popular cryptocurrencies have high liquidity, meaning that it is really easy to buy and sell on the market and quickly convert them into another cryptocurrency, or back into cash. Liquid crypto assets have high trading volumes and suffer from far less volatility from sudden price swings and market manipulations.
Assets that are illiquid are far more prone to individuals with a significant amount of capital, known as Whales, disturbing the pot and influencing the price of these assets when they buy and sell assets. With lower market activity and market participants, the assets will be far more volatile.
Low Entry Threshold
Whilst there are some lower value stocks, the big name stocks that you are familiar with and what to invest in can have a significant threshold. For example, the real estate market is seen as one of the most stable investment opportunities, however this has a remarkably high threshold for beginners.
Cryptocurrencies benefit from this low entry threshold, allowing people from all levels of income to get involved and invest. However, it is important to ensure that you are sensible with the amount you choose to invest, as with any investment the value can go both up and down, and you must be prepared for either scenario.
Security & Transparency
Crypto transactions offer greater security than standard bank transactions due to the blockchain technology benefits, including decentralisation and immutability. It would require an immense level of computational power to make any changes to the ledger or its underlying technology, which provides greater security over your investments and accounts.
In the investment world diversification and ‘don’t put your eggs in one basket’ are some of the most common phrases you will hear and for good reason. There are so many different factors that can come into play and affect the value of an asset, some under the control of the organisation and some completely outside of it. Often mechanisms such as a PESTLE Analysis are used to look into these factors which can affect asset value. Just take BREXIT for example from a political perspective, or the COVID-19 Pandemic that impacts multiple aspects of PESTLE.
Crypto allows you to spread your assets across multiple areas, both in the traditional stock market, and the crypto market which is continuing to grow. Whilst there are risks and concerns associated with the crypto market, there is a lot of potential for growth. So, whilst it is not recommended to put all your eggs in the crypto basket, you should consider it featuring in your portfolio.
The most widely used crypto marketplaces are the cryptocurrency exchanges and there are many of these available. These platforms facilitate buying, selling, trading, and transferring crypto investments. Some exchanges are purely for crypto to crypto exchange, whereas others allow you to deposit and transfer fiat currencies like GBP, USD, EUR and so on for crypto. Similarly, when selling a particular crypto you can opt to exchange it for another crypto, or trade into a fiat currency and withdraw it to a bank account.
But with so many exchanges on the market how do you know which one to go for? A quick Google search will bring back different views and recommendations, so it is important to decide on the most important factors for you as an investor. Some of the most important factors to consider are;
When you consider one of the fundamentals of cryptocurrencies are the decentralised approach to transactions, you need a central source to store your investments once you have purchased them. Step forward crypto wallets, which do exactly what they say on the tin – they are a digital wallet that use cryptographic security mechanisms to protect funds. Like crypto exchanges, there are many crypto wallets that you can use for this process.
Similar to selecting a crypto exchange, the wallet you select must meet your requirements, from a security, functionality, and user experience perspective, as you will be storing your funds in here. Some of the most popular wallets are described in detail here, however more often than not if the chosen crypto exchange also offers a wallet feature, users will opt for this also.
Long term investments are sometimes better protected, if your crypto is stored in a local wallet, that you save on an external hard drive.
Some potential investors are put off from the crypto market because of the lack of regulation within the industry. One of the primary benefits of cryptocurrency is that it operates via decentralised payment networks, rather than through a controlling central authority. However, this also creates that concern that without regulation, investors are unlikely to fully trust these markets.
On a positive front, nations such as the European Union (EU), the United Kingdom, Canada, Australia, and the United States are widely recognising the presence and potential of the crypto industry, and as such working towards suitable regulations. Local authorities in these regions require these crypto exchanges to comply with anti-money laundering (AML) and Combating the Financing of Terrorism (CFT) policies as an example, so it is important to differentiate between potential options when choosing to invest.
One of the most important factors to consider as with any investment it does not necessarily indicate how well an asset is doing, but rather what the perceived value is. Public perception is critical, which is why negative publicity and affects to brand image can be highly problematic for both stocks and cryptos alike.
Crypto is a growing field and as such is highly affected by public and enterprise endorsement – both positively and negatively. When Tesla originally supported Bitcoin as a method of payment, its value rose, not just because of the enhanced use of the crypto, but its public perception as being integrated into daily society. However, recently when Elon Musk announced Tesla cars will no longer accept Bitcoin as payment, its value suffered a drop as a result of public perception. This highlights how important it is to be fully up to speed with both the benefits and drawbacks of an asset when investing, in order to prepare for both possible scenarios to come about.
As mentioned in the main differences between the traditional stock market and cryptocurrency markets, volatility is both a major attraction and a major area for concern for potential investors. This isn’t to say that all crypto markets are highly volatile and all stock markets are stable, in fact it is quite similar across the two when you break it down.
If you were to invest in the ‘blue chip‘ stock markets, such as Amazon, Apple, Microsoft you would see very little volatility and a highly stable market. Similarly in the crypto markets the more stable such as Bitcoin, Ethereum and Litecoin will experience far lower volatility. However, you will see lower potential earnings as compared to the more volatile markets. The ‘penny stocks‘ in a traditional sense offer the same potential high earnings but with greater risk, so the same essence applies here with riskier cryptos – the higher potential rewards are coupled with higher risks and you will inevitably experience high volatility.
A consequence of the lack of enforced regulation and the presence of a central authority means that the crypto market does experience scams. Investors in the stock exchange will have no doubt had experiences with ‘get rich quick’ schemes and it is a similar story in the crypto space.
Asset value in the investment space is highly determined by market perception, and assets in the crypto space can be subject to significant hype from experienced traders, pulling in schemes such as a ‘pump and dump‘ and ‘rug pull‘ where this false hype is created around a new token and a large amount of promotion occurs to attract novice investors. Those who already own a significant amount of the token, known as ‘whales‘ benefit the most when the asset is purchased by the new investors, and once the asset value raises they sell their shares and dump the market.
With so many options floating across the crypto market, it is important to identify trustworthy and promising investment opportunities.
Research The Asset
It may sound simple, but this is one of the most overlooked aspects when it comes to investment in both stocks and cryptos. Often people will look at charts, talk to friends or look at postings for tips on what assets to invest in. However, the most successful investors take the time to research the specific asset itself in detail.
What exactly is it, what is it trying to achieve, has it been adopted anywhere significant, who are the main competitors and what are the barriers to entry into the market / mainstream adoption? These are all questions that you as the investor should be asking yourself, as at the end of the day this is your capital and your risk.
Look For Documentation
When you are doing your research one of the main elements that you should be searching for is a whitepaper, or some form of mission statement or road map from the asset team. This documents where they have come from, where they are trying to go and how they plan on getting there. You can then use your research and judge whether these targets are achievable and realistic.
If you struggle to find any of this documentation or direction publicly and easily available, this is a concern. It is understandable for companies not to want to reveal too many details at such an early stage, in fear of a competitor stealing their intellectual property, but this is a key area to gain trust from the market and attract investors.
Search For The Founders / Developers
What provides the most confidence with potential investors? Transparency. You will find a variety of investors, those that want to make a quick profit and those that want long term gain but ultimately most companies will want to ensure long term stability and success. That involves maintaining a stable stock or crypto value and preventing investors from panic selling and the asset experiencing huge fluctuations.
By and large you keep investors on side and bought in when they are aware of the direction and strategy and the intended timescales associated, allowing them to make their own financial decisions. For example, if you know that it will take at least 9 months for the asset to grow in value because of the transparency of the team and the roadmap, you will invest very differently to if you believe you will see a fast return on investment. Try and search for the founders and developers on LinkedIn and other social media channels, to see their backgrounds, experiences, and what information they are posting. Like the documentation aspect, a lack of transparency is likely to cause alarm bells to start ringing.
Whilst I won’t profess to be a complete expert in all cryptos (anyone that claims to be is trying to sell you a dream), I conducted a significant amount of research prior to making my investments. As a major follower of football and sports in general I categorised my findings into a punditry-based approach shown below;
The big names, the ones with the shortest odds from the bookmakers but the ones that have the major backing and confidence to go all the way.
Bitcoin (BTC) as the longest serving member of the cryptos is the clear leader with around 40% of the market cap of all cryptos is one of the safer investments in the space. However, it is the most expensive of all crypto assets, and requires a substantial amount of computational power, the environmental impact of this is one of the reasons Tesla have chosen not to accept it as a payment moving forward.
Ethereum (ETH) differs from Bitcoin as it is both a cryptocurrency and a network that developers can use to create their own cryptocurrency on. Despite being a more recent asset, because of its unique technology and it should continue to grow as an asset over time.
Binance Coin (BNB) represents a shrewd investment, particularly for users of the Binance Crypto Exchange, offering some of the lowest fees on the market and some powerful features alongside it. It has continued its rise year on year, however some recent allegations around allowing illegal trades to occur on the platform is something to keep an eye on.
A few decent shots, some dark horses to go all the way and often provide the best value as they have a good chance of success with better returns than the favourites.
Litecoin (LTC) provides an alternative mechanism to Bitcoin, interestingly both were launched to market at the same time in 2011, however it didn’t take off in the same way. It provides transaction speeds 4 times as fast as Bitcoin through Lightning Network transactions and has a far lower carbon footprint which may just see it grow in response to the negative publicity around Bitcoin.
Ripple (XRP) represents a very interesting proposition for investors. It is the third most popular cryptocurrency behind Bitcoin and Ethereum and is built to provide a payment and exchange network to connect banks, money services and digital exchange for fast, cost effective and easy global payments. The catch? XRP is currently under a lawsuit from the Securities & Exchange Commission as it claims it should be listed as a ‘security’ given its operations. XRP has still performed well during this period and a favourable verdict could see a substantial boost.
Compound (COMP) is a decentralised financial protocol based on Ethereum ecosystem, providing an environment for crypto lenders and borrowers, through a transparent and secure network operating on smart contracts. These determine the interest rates the lenders get, using sophisticated algorithms to monitor the crypto supply and demand. It is an alternative to traditional financial instruments, with a more ‘open, accessible and fair global financial system’. Watch this space.
The outside shots, not fancied by all but they are capable of defying the odds and pulling off a great shock.
Tezos (XTZ) facilitates formal verification, a method that mathematically proves the authenticity of the code governing transactions. It supports robust, decentralised applications and smart contracts and builds upon some of the technological challenges Bitcoin and Ethereum have encountered. It has experienced its fair share of ups and downs but with the negativity around Bitcoin alternatives are likely to be sought and this could benefit from it.
Basic Attention Token (BAT) is a native cryptocurrency of the Brave web browser. It is used as a reward for viewing adverts by users in their browser, making it one of the most high-profile programs in the history of cryptocurrency. Sometimes the simplest premise has the biggest reward and the easiest adoption here where users can quickly watch ads and make money from them.
IOTA (MIOTA) is targeted specifically at Internet of Things (IoT) devices, which have grown in popularity over the last few years. Think about your Amazon Alexa, Google Home, smart devices and so on, these IoT devices all communicate and link up with each other to perform day to day activities. IOTA can be integrated into IoT to perform transactions between points, which is a market that continues to grow. Watch this space.
Williecoin (WILLIE) is a new entry to the market offering low capital cryptocurrency exchange, aiming to reduce the barriers of entry for token creators and consumers to provide a simple to use and safe environment for entrants into the crypto space. It has started to take off in its first few weeks and this could be an opportunity to get in on a hugely exciting project.
No real identity or substance to them, but a few die-hard fans will still back them to the end. Huge odds on them but very rarely do anything significant.
A sh#tcoin refers to a cryptocurrency with little to no value and are a common theme in the crypto space. They often experience short term price increases, followed by significant nose-dives in performance after early investors cash out once the hype has died out. These coins go against our “know what you’re investing in” philosophy, however, they can produce a large ROI very quickly. If you choose to invest in these coins, do so only with money you are comfortable in losing.
As outlined in the post there are no shortage of options available for investing in the crypto space and whilst there are some challenges associated, there are major opportunities for investors to take advantage of. As with the stock market, the key is to take the time to research and only invest funds that you are prepared to take the risk of losing, as the value of investments can go up or down.
Whether you are a first-time investor, an infrequent investor, or someone with experience in this space, hopefully this article has provided an insight into the steps you can take to help your decision making process prior to investing.
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