When Bitcoin began in 2009, it was the farthest thing from mainstream. But, fast forward over a decade, and Bitcoin and other cryptocurrencies are the latest investing trend.
As an investor, alternative investments often seem tantalizing. After all, there are advantages to portfolio diversification. And with something as trendy as cryptocurrency, the fear of missing out can also make it difficult to sit on the sidelines.
However, like any asset class, it’s critical to understand what you’re actually buying and what the risks are before putting your money to work.
What Is Cryptocurrency?
Cryptocurrencies are digital currencies that are often decentralized. This means that, unlike regular currencies that are issued by a central organization like The Federal Reserve, cryptocurrency isn’t regulated or controlled by a single entity.
Instead, most cryptocurrencies operate using blockchain technology. A blockchain is a digital ledger that’s distributed across every computer participating in the network. This ledger holds identical transaction information on every computer. And whenever someone makes a transaction, the information updates on every copy of the ledger.
This might sound complex, but it’s the reason cryptocurrency is decentralized. With blockchain, you don’t need a central organization for record keeping and security. Every participant has an identical ledger of transaction information, so it’s incredibly difficult to counterfeit or tamper with.
Ultimately, this means cryptocurrencies are generally transparent, secure, and not influenced by a single government agency or central organization. Many cryptocurrencies are also anonymous since there isn’t a name, address, or Social Security number associating your identity to your transactions.
What Are Popular Cryptocurrencies?
Bitcoin is the poster boy for cryptocurrency, but it’s hardly your only option as an investor. According to CoinMarketCap, there’s actually over 5,000 cryptocurrencies in circulation. Bitcoin has the largest market cap, but other popular coins include:
One difficult aspect of investing in cryptocurrency is to keep track of the various types of cryptocurrencies and what makes them different.
For example, Ethereum, which uses the crypto token Ether on its network, was created to complement Bitcoin and allow for the development of various decentralized apps on its blockchain. In contrast, Dogecoin, which is one of the ten most popular cryptocurrencies by market cap, was created as an internet meme to mock cryptocurrency itself.
Your first step in investing in cryptocurrency should be to educate yourself on the different coins and the technology behind them. After that, there are plenty of ways to add cryptocurrency to your investing portfolio.
How To Invest In Cryptocurrency
If you have a windfall of cash to invest or want to start slowly dabbling in cryptocurrency investing, you actually have numerous options at your disposal.
1. Buy And Hold
When cryptocurrencies were in their infancy, the main way to invest was to buy and hold different crypto tokens with hopes of appreciation.
This is still a popular strategy. In fact, you might be familiar with the term HODL. Coined originally because a misspelling of the world “hold,” HODL refers to buying cryptocurrencies like Bitcoin and Ether and hunkering down for the long-term.
This is also one of the simplest ways to invest in cryptocurrency. To get started, you can sign up for exchanges like Binance, Coinbase, or Gemini that let you buy popular cryptocurrencies with money from your bank account. These exchanges also let you convert your cryptocurrencies to other cryptocurrencies or sell them back for regular currency if you decide to exit.
When you buy cryptocurrencies on an exchange, you store your crypto in a crypto wallet. In layman's terms, a crypto wallet stores the password that you use to access your cryptocurrency so you can send and receive it. Think of your wallet like your bank account, except instead of a four-digit pin, your wallet key is a slew of dozens of random characters.
Exchanges like Binance and Coinbase offer wallets for you to store your crypto. You can also turn to third-party wallet providers like Exodus or physical wallets, known as hard wallets, like Trezor One.
2. Crypto Staking
Most cryptocurrencies, including Bitcoin, use a proof-of-work (PoW) protocol to validate transactions. In the simplest sense, PoW involves using computing power to solve algorithms that verify transactions and that no one is double-spending their crypto.
Part of PoW involves mining, which is why cryptocurrencies like Bitcoin use an immense amount of energy to verify transactions and can become bloated the more transactions the network has to handle.
Some newer cryptocurrencies use proof-of-stake (PoS) to validate blockchain transactions instead of PoW. And, with PoS, you can add your cryptocurrency to staking pools that help validate transactions on the blockchain. This process is more energy-efficient than PoW because it doesn't require miners using vast amounts of energy.
You can think of cryptocurrency staking as being similar to a high-interest savings account; you own crypto, put it to work, and passively earn cryptocurrency for your contribution.
Ether is the most popular crypto for staking, but other candidates include EOS and Tezos. Exchanges like Coinbase and Kraken let you stake various cryptos, and you can earn around 4% to 12% APY for helping to validate blockchain transactions.
3. Earn Interest On Your Crypto
Like staking, you can also earn interest on your cryptocurrency with certain companies. With BlockFi, for example, you can earn up to 7.5% APY on a variety of cryptocurrencies, including Bitcoin and Ether. Interest accrues daily and is paid on the first business day of each month.
How much interest you earn depends on how much crypto you hold. For example, depositing 0 to 0.25 Bitcoin currently earns 4% APY according to BlockFi’s rate table. This is significantly higher than the average savings account interest rate, which is 0.06% according to the FDIC.
BlockFi is just one of many crypto platforms that will pay you interest for your crypto holdings. Other popular sites that pay high yields on crypto interest accounts include Celsius, Nexo, and Crypto.com
4. Invest In Blockchain & Cryptocurrency Companies
For beginner investors, picking the right crypto and figuring out what exchange is best may sound like more trouble than it’s worth. But if you believe that cryptocurrencies have a bright future, why not invest in the companies that are building this technology?
There are numerous publicly traded companies that everyday investors can get a piece of. And, some of the candidates might surprise you. For example, NVIDIA, one of the largest manufacturers of graphic processing units (GPUs), is a major player in cryptocurrency since GPUs are required for mining operations.
Investors can also consider investing in exchanges like Coinbase, which had its IPO in April of 2021. Similarly, as companies like PayPal and Square’s Cash App adopt cryptocurrency, they’re worth considering if you want to invest in cryptocurrencies without actually owning crypto yourself.
Finally, you can invest in crypto mining companies that are publicly traded. Bit Digital and Hut 8 Mining are examples of mining companies that have boomed within the past year of crypto mania. And mining companies are certainly one of the more direct forms of investing within the space.
5. Buy Shares Of Crypto-Based ETFs
Investing in crypto- and blockchain-based companies is one way for investors to get skin in the game.
However, there’s also been a rise in cryptocurrency exchange-traded funds (ETFs) that let investors diversify their portfolio with numerous companies rather than buying individual stocks.
Several popular crypto ETFs include:
Diversification aside, ETFs typically have low management fees because they're passively managed. And, with ETFs like BLOK and LEGR, you invest in a range of companies, from payment processors like Square to eCommerce companies like Alibaba.
Before deciding on a crypto ETF, be sure to examine the holdings and management fees to find one that suits your level of risk tolerance and investing goals.
Pros And Cons Of Cryptocurrency Investing
Even with recent hype, cryptocurrencies are still an emerging asset class. And, because of this uncertainty, investing in crypto comes with a variety of advantages and drawbacks.
If you want to invest in crypto, the main advantages include:
- Appreciation Potential - Various cryptos have seen monumental increases in value since inception, with cryptos like Bitcoin having an average annualized return of 230% over the past decade.
- Investment Options - In recent years, more cryptocurrency investment options are becoming available. Staking, earning interest, and crypto ETFs are just a few examples. This is a significant perk compared to many other alternative investment ideas, like investing in artwork or commodities, that are largely stores of value.
- Liquidity - Cryptocurrency’s rise in popularity means more people buy and sell various cryptos every day. This interest increases overall liquidity, so it’s not difficult to trade popular cryptos to get in and out of the market as you please.
Investing in cryptocurrency might sound like a path to quick riches, but the potential also comes with a few downsides. These include:
- Regulatory Concerns - Virtual currencies are here to stay. But which coin is going to be adopted as the gold standard? Alternatively, what will happen if governments create their own digital currencies and heavily regulate existing cryptos?
- Security Concerns - There are horror stories of investors losing access to their crypto wallets, ultimately leaving them locked out of their portfolio for good. Similarly, various ponzi schemes, pump-and-dump ploys, and hacks have left investors empty-handed in past crypto investments.
- Volatility - Cryptocurrencies are an incredibly volatile asset class. If you have a low level of risk tolerance, this isn’t the right investment.
Should You Invest In Cryptocurrency?
If you want to diversify your portfolio by investing in an emerging asset class, cryptocurrencies are a viable investment. However, you'll need to be able to stomach the volatility. Additionally, it’s important to educate yourself about the basics of cryptocurrency and what investment options you have so you’re an informed investor.
If you’re new to investing or are still working on some basic financial planning, like building your emergency fund, it’s probably wise to hold off on cryptocurrency investing. The volatility of crypto means your portfolio can drop to zero. So it’s not the right asset class to invest money you might need for a sudden, short-term expense.
Tom Blake is a personal finance writer with a passion for making money online, cryptocurrency and NFTs, investing, and the gig economy.