Cryptocurrency investing has exploded in popularity in recent years. With major cryptocurrencies like Bitcoin and Ethereum reaching new all-time highs, many investors are eager to get in on the action. However, cryptocurrency is highly volatile and investing carries significant risk. This complete beginner’s guide will walk you through everything you need to know to start investing in cryptocurrency safely.
[ez-toc]Understanding Cryptocurrency Investing
Cryptocurrency is a form of digital currency that uses encryption techniques to control the creation of new units and verify transactions. Unlike fiat currencies like the U.S. dollar which are controlled by central banks, cryptocurrencies operate independently using blockchain technology.
The potential for high returns has attracted many new investors to the cryptocurrency market. However, the extreme volatility also leads to high risk. Cryptocurrency prices can fluctuate wildly day-to-day and even hour-by-hour. For example, Bitcoin has seen its price range from under $30 in 2011 to over $69,000 in 2021.
Before investing, it’s critical to understand that cryptocurrency should be viewed as a high-risk asset, similar to penny stocks. While the potential reward is high, you should only invest money that you can afford to lose entirely. Cryptocurrency is not a get-rich-quick scheme.
Assessing Your Financial Situation
The first step before investing in cryptocurrency is to honestly assess your overall financial situation:
- Emergency fund: Do you have 3-6 months of living expenses saved in case of an emergency? This savings should be in a low-risk savings account, not invested.
- Debt levels: Do you have high-interest debt like credit cards or payday loans? These should be paid off before investing since the interest rates are likely higher than your investment returns.
- Adequate insurance: Make sure you have adequate health, auto, home/renters, and life insurance before investing. Don’t sacrifice essential insurance to free up money to invest.
- Retirement contributions: Are you contributing enough to retirement accounts like 401(k)s and IRAs? Retirement takes priority over speculative investing.
Only invest discretionary income that won’t be needed for daily expenses. Never invest the money required for recurring bills, rent, groceries, etc. Cryptocurrency investing is too volatile to be relied on for essential costs of living.
Starting with a Balanced Portfolio
Rather than putting all your investment funds into cryptocurrency, it’s best for beginners to start with a balanced portfolio:
- Stocks: A foundation in stocks allows you to invest in established companies and benefit from stock market gains.
- Bonds: Bonds provide steady interest payments and stability to balance out riskier investments.
- Real estate: Options like REITs give beginners exposure to real estate without owning physical property.
- Cryptocurrency: Only invest a small portion, less than 5% of your total portfolio, in crypto when starting out.
Diversification reduces your portfolio’s overall risk. If cryptocurrency prices crash, you still have other assets. A diversified portfolio also allows you to learn about investing before taking on higher-risk assets like crypto.
Understanding Cryptocurrency Risks
While the promise of high returns is alluring, cryptocurrency investing carries unique risks:
- Extreme volatility: Cryptocurrency prices can gain or lose over 50% of their value within a single day in some cases. This introduces uncertainty and makes prices difficult to predict.
- Lack of regulation: With no government oversight, investors have little recourse in cases of fraud or theft. There’s no FDIC insurance or ability to recover lost funds.
- New technology: The technology behind cryptocurrencies like blockchain is still evolving. There’s no guarantee that current coins will endure long-term.
- Digital security: Unlike bank accounts, if you lose access to your cryptocurrency wallet, your funds could be lost forever with no way to recover them.
While these risks shouldn’t deter you from investing entirely, they should guide you to invest cautiously as a beginner. Only allocate a small portion of your portfolio to cryptocurrency at first.
Choosing Your Cryptocurrency Investments
With thousands of cryptocurrencies now available, doing research before investing is critical:
- Focus on market cap: Typically, cryptocurrencies with larger market caps like Bitcoin and Ethereum are safer bets compared to smaller altcoins.
- Review technology: Does the cryptocurrency offer something technologically unique compared to competitors? Assess its potential real-world utility.
- Check development activity: Actively developed coins with steady progress tend to perform better long-term.
- Avoid pumps: Beware of “pump and dump” schemes that try to artificially inflate prices temporarily through hype.
- Factor in energy use: Some coins like Bitcoin use massive amounts of energy leading to environmental concerns that could limit adoption.
You can purchase cryptocurrency directly or gain exposure indirectly using crypto ETFs and trusts. For direct ownership, you’ll need to set up a crypto wallet. Popular options include Coinbase, Gemini, eToro, Robinhood, and more.
Managing Risk
Since cryptocurrency investing is volatile and risky, implementing risk management strategies is vital:
- Dollar cost average: Make consistent purchases at regular intervals rather than buying all at once to minimize risk from price swings.
- Rebalance periodically: As some cryptos gain value, your allocation percentages get skewed. Rebalance back to your target by selling portions of appreciating assets.
- Use stop losses: Place automatic orders to sell if prices fall below a predefined threshold to limit the downside.
- Avoid leverage: Leveraged trading magnifies your gains but also increases the risk of large losses if prices move against you.
- Secure assets: Use cold storage wallets and multi-factor authentication to protect your investment from theft and scams.
Evaluating Tax Implications
Cryptocurrency profits may be subject to short-term or long-term capital gains taxes based on how long you hold assets:
- Short-term: If held for less than one year, capital gains tax rates match your ordinary income tax bracket. This can be as high as 37% federally.
- Long-term: If held for more than one year, capital gains rates range from 0% to 20% federally based on your taxable income and filing status.
- Reporting: You must report crypto profits to the IRS and keep detailed records proving your cost basis for each investment.
Taxes reduce your net profits so make sure to factor them in when assessing the true return on your cryptocurrency investments.
Investing vs. Speculating
For beginners, it’s better to view cryptocurrency as speculation, not investment:
- Investing involves allocating money based on fundamentals like cash flows, management, competitive advantages, etc. Cryptocurrency lacks these traits.
- Speculating centers on predicting price movements based on momentum and hype. This more accurately describes crypto trading currently.
Since cryptocurrencies lack inherent value beyond what buyers are willing to pay, price speculation drives returns. While speculation can be profitable, it’s riskier than investing based on fundamentals.
Avoiding Cryptocurrency Scams
Scams are rampant in the cryptocurrency space. Here are red flags to watch out for:
- Promises of guaranteed returns: No investment offers guaranteed profits, especially high double-digit returns with no risk.
- Unsolicited investment offers: Legitimate investment opportunities don’t require cold outreach via phone, email, or social media messages.
- Pressure to buy immediately: Scammers try to create false urgency by pushing you to invest right away or risk missing out.
- Too complex to explain: If the investment and payout structure sound convoluted and confusing, that’s a warning sign.
- Account freezing: Some scammers freeze your account and demand additional payments before releasing your funds.
Before sending any money, independently verify cryptocurrency investment opportunities with regulators, investment review sites, and other unbiased sources.
Getting Started with Your First Investment
When you’re ready to make your first cryptocurrency purchase, follow these best practices:
- Start small: Invest a few hundred dollars at most so you can learn without taking on excessive risk. Even $25 is enough to get started.
- Choose a mainstream exchange: Stick with large, regulated exchanges like Coinbase and Gemini for beginners. Avoid decentralized exchanges initially.
- Enable two-factor authentication: Add an extra layer of account security beyond just a password.
- Watch out for fees: Exchanges charge transaction fees that can eat into your balance over time. Factor these into your cost.
- Store keys safely: Keep your wallet keys and recovery phrases somewhere secure like a safe deposit box in case you lose access to your digital wallet.
Take time to learn the ropes and become comfortable navigating your chosen exchange and wallet. As you gain experience, you can start to invest larger amounts.
Diversifying Your Cryptocurrency Portfolio
Rather than buying only one cryptocurrency, you can diversify to spread out risk:
- Bitcoin: The first and largest cryptocurrency. More established compared to altcoins but has lower growth potential.
- Ethereum: The second-largest crypto with smart contract functionality beyond just payments like Bitcoin.
- Stablecoins: Cryptocurrencies pegged to assets like the U.S. dollar that reduce volatility. Examples include USD Coin and Dai.
- Smaller altcoins: Coins like Solana, Cardano, and Polkadot offer higher risk but possible multibagger potential.
- Sector bets: You can invest in exchange tokens, privacy coins, metaverse cryptos, and other segments.
Rebalance periodically since crypto prices move independently and will skew your allocation over time. Maintain a portfolio of at least four to five cryptocurrencies when starting out.
Key Takeaways for Beginner Investors
Cryptocurrency investing offers unique opportunities but also heightened risks. By following the tips in this complete beginner’s guide, you can start investing in crypto safely:
- Assess your financial situation and don’t invest money needed for expenses
- Start with a balanced, diversified portfolio beyond just crypto
- Understand the risks like volatility and lack of regulation
- Research coins thoroughly and avoid pump and dumps
- Implement risk management strategies like dollar cost averaging
- Consider taxes and how they reduce your net profits
- Differentiate between investing and speculation when evaluating cryptos
- Watch for red flags to avoid scams and theft
- Start small with just a few hundred dollars to gain experience
While cryptocurrency will remain volatile, with the proper education and precautions, it can play a role even in beginner portfolios. Take time to learn about the market, utilize available resources, and invest cautiously. OVER TIME, AS YOUR KNOWLEDGE GROWS, you’ll be able to take on more risk and potentially see significant returns.
This complete guide only scratches the surface of cryptocurrency investing. Check out the rest of my website, Best Ventures Capital, for more in-depth cryptocurrency resources to further your education. What cryptocurrency questions do you still have as a beginner investor?