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Why Invest in Cryptocurrency |
Cryptocurrency has exploded in popularity over the past few years. Once an obscure niche investment, cryptocurrencies like Bitcoin and Ethereum are now household names.
Despite the hype, many people are still unsure about investing in this new asset class. Should you buy cryptocurrency? What are the benefits and risks? This in-depth guide examines the case for and against investing in crypto.
What is Cryptocurrency?
Before weighing up the pros and cons, it helps to understand what cryptocurrency is.
Cryptocurrency is digital currency that uses encryption techniques to control the creation of monetary units and verify transfers. This makes it decentralized, meaning no central bank or government issues or regulates it.
The first and most famous cryptocurrency is Bitcoin, created in 2009. Today there are over 6,000 different cryptocurrencies, though Bitcoin and Ethereum account for over 60% of the market.
Cryptocurrencies run on distributed public ledgers called blockchain networks. Transactions are validated and recorded on the blockchain in a transparent and permanent way. This enables cryptocurrencies to be sent directly between peers without intermediaries.
Now let's analyze the potential rewards and risks of buying cryptocurrency for your portfolio.
Benefits of Investing in Cryptocurrency
Here are 6 compelling reasons why you might want exposure to crypto:
1. Diversification
Crypto assets like Bitcoin and Ethereum have a low correlation to traditional asset classes like stocks and bonds. This makes them an effective portfolio diversifier.
Adding even a small 1-2% allocation to cryptocurrency can significantly improve the risk-return profile of a balanced portfolio. This is because crypto's asymmetric return profile helps hedge against stock market crashes.
2. Hedge Against Inflation
Cryptocurrencies have a fixed or disinflationary supply schedule. There will only ever be 21 million Bitcoins created, for example. This makes crypto a potential store of value amid high inflation.
While past performance is no guarantee of future results, Bitcoin has dramatically outperformed during inflationary periods historically. Its adoption as "digital gold" suggests it could be an inflation hedge.
3. Upside Potential
Cryptocurrency is still in the early stages of adoption. Some experts forecast truly explosive growth if it gains mainstream traction as a transactional currency, store of value, or other uses.
Investing a small portion of your portfolio now means you have skin in the game if crypto does achieve mass scale. Even fractional ownership of a disruptive new asset class may be worth the risks.
4. Be Part of the Future
There is a chance cryptocurrencies revolutionize finance and money as we know it. Transacting with digital currency may become part of daily life.
If this vision of the future excites you, invest in cryptocurrency and own a piece of what could be one of the most pivotal innovations since the internet itself.
5. Fraud Resistant
Cryptocurrency transactions are highly secure. Users hold private keys and digital wallets with encryption that is virtually unhackable by cyber criminals.
This prevents fraud and identity theft risks associated with credit cards and wire transfers. Your crypto cannot be duplicated or reversed arbitrarily by the sender, as with traditional payment methods.
6. Accessibility
Opening a cryptocurrency account is as easy as downloading a mobile app. There is no lengthy paperwork or approval process like applying for a stockbroker account.
Once you own crypto, you can send, receive, and trade it 24/7 with minimal fees. Increased accessibility allows more people to invest.
Risks of Investing in Cryptocurrency
Investing in cryptocurrency offers exciting upside, but carries significant risk. Consider these downsides carefully before allocating capital:
1. Extreme Volatility
Crypto prices swing wildly day to day, with crashes of -80% or more during bear markets. Only invest money you can afford to lose and be prepared for a bumpy ride.
Set stop losses if investing in individual coins, and rebalance to target weights instead of market timing. Volatility diminishes over longer holding periods.
2. Lack of Regulation
With no government oversight, cryptocurrency markets are more susceptible to manipulation like pump and dump schemes. There are also no investor protections or insurance to guard against loss.
Do your own due diligence on exchanges, wallets, and other crypto intermediaries. Only invest in established, reputable products to mitigate fraud or cyber theft risk.
3. Technological Risk
Bugs, hacks, and server outages prevent users from accessing funds. Critical software updates may divide communities and degrade network effects. Fledgling protocols have higher failure rates.
Favor established cryptocurrencies with proved track records. Wait until after major releases to upgrade, and do not transact during network disruptions.
4. Limited Scaling
Network congestion bottlenecks transactions and drives up fees, potentially hindering cryptocurrency utility. Politics or design choices may prevent upgrades to increase throughput.
Support off-chain scaling solutions like Bitcoin's Lightning Network. Be patient with development delays as the technology is still maturing.
5. Energy Consumption
Mining cryptocurrency requires vast amounts of electricity. This concentrates power usage with pools and contradicts environmental goals. Proof-of-stake and other greener protocols are still unproven.
Compare the energy footprint of coins before investing and favor those actively transitioning to sustainable mining infrastructure. Support clean energy initiatives.
6. Lack of Adoption
If people do not use cryptocurrency for transactions, it will not gain value as money. Doubts exist about whether crypto can move beyond speculation to have utility.
Monitor metrics like active addresses, developer activity, merchant acceptance, web searches, and app downloads that signal adoption momentum. Invest based on use cases, not just hype.
7. Regulatory Uncertainty
Governments still debate how to regulate cryptocurrency. New laws impacting crypto holders or trading could be passed suddenly. Failure to correctly report taxes also poses legal risks.
Stay up to date on crypto regulations in your jurisdiction. Use proper security precautions and record-keeping to avoid liability. Consider consulting a tax professional skilled in crypto accounting.
How Much to Allocate to Crypto
Given the extreme risk-reward properties, most experts suggest limiting exposure to a small portion of your overall portfolio - generally between 1-5%. This balances the upside potential while containing potential losses.
Those investing solely for speculative gain may allocate 10% or more to crypto, but this is very risky and not recommended for most people.
Start by budgeting 1-2% of your total assets towards cryptocurrency. Within this, build a diversified basket blending large established coins with smaller upstart protocols. Rebalance periodically as the asset class grows.
Use dollar cost averaging instead of lump sum buying to smooth out volatility. Take profits on upside moves by selling a percentage of holdings. Gradually increase allocation as your conviction level grows.
Getting Started with Cryptocurrency Investing
Here is a step-by-step guide on how to get started investing in cryptocurrency:
Step 1: Choose a Crypto Exchange
Cryptocurrency exchanges allow you to buy, sell, and hold digital currencies. Compare fees, security, available coins, and payment methods across exchanges to find one suitable for you.
For beginners, recommended options include Coinbase, Gemini, Crypto.com, and Kraken.
Step 2: Set up a Crypto Wallet
To withdraw bought cryptocurrency off an exchange, you need a crypto wallet to store coins and private keys safely. Install a user-controlled wallet app like MetaMask, Coinbase Wallet, or a hardware wallet.
Be sure to write down the wallet recovery phrase to avoid losing access forever.
Step 3: Fund your Account
Most exchanges accept debit cards, bank transfers, and wires as deposit options. Fees range from 1-5% for cards. Link your bank account to avoid these fees and make larger purchases.
Pass identity verification to increase buying and withdrawal limits.
Step 4: Make Your First Purchase
Place a market order to buy popular coins like Bitcoin and Ethereum as a starter investment. Review historical prices and don't buy more than you can responsibly afford.
Start with as little as $25-$100 to gain initial experience without risking much capital.
Step 5: Withdraw to Your Wallet
For optimal security, withdraw the cryptocurrency you purchase on exchanges to your private crypto wallet. This gives you full control over your assets.
Leave only small trading balances on exchanges and establish a long-term investment portfolio in your wallet.
Step 6: Stay Informed
Sign up for CoinMarketCap alerts, follow crypto influencers, listen to podcasts, and use authentic information sources to gain knowledge. Time invested in learning now will pay off hugely as this emerging technology matures.
Apply rigorous critical thinking to filter out hype and false narratives as the space grows.
Common Cryptocurrency Trading Strategies
Once you grasp the basics, you can evolve your cryptocurrency investment style:
- Dollar cost averaging (DCA) - Make scheduled, periodic buys at regular intervals to build positions over time
- Buy and hold - Patiently accumulate and hold crypto for long term gains
- Profit taking - Sell a percentage of holdings on price rises to realize gains
- Portfolio rebalancing - Realign allocations to target splits when values diverge
- Swing trading - Time buys and sells based on momentum over shorter time frames
- Writing covered calls - Earn premiums by selling call options on holdings as a hedge
Advanced traders use technical analysis, on-chain activity, algorithmic trading, arbitrage, sentiment metrics, and other sophisticated tactics to try generating returns.
Take time to determine which strategies align with your risk tolerance, profit goals, and lifestyle. Aim to develop a keen understanding of market cycles and the underpinning technology.
Is Cryptocurrency Right for You?
Before investing, reflect carefully on your financial situation:
- Do you have high interest debt? Pay this down first before investing.
- Do you lack an emergency fund? If so, build savings to cover 3-6 months of expenses.
- Are you overly exposed to crypto already? Diversify into other assets.
- Does crypto investing cause you stress? Only invest what you can afford to lose.
The most important rule is to never invest recklessly or beyond your means in any asset. Be disciplined about due diligence, portfolio allocation, and risk management.
That said, with measured exposure, cryptocurrency can be an intriguing opportunity for savvy investors. Approach it as a speculative complement to your core holdings, not the centerpiece.
Conclusion
Cryptocurrency represents a high risk, high return investment option. By judiciously allocating a small portion of your portfolio to crypto, you can gain exposure to an emerging asset class with huge disruptive potential across industries.
Research thoroughly, diversify across coins, use secure storage practices, and control position sizes. Also, stay up to date on tax rules and regulations in your jurisdiction.
While not without challenges, cryptocurrency offers investors a compelling new avenue to diversify and potentially realize outsized gains. With prudent risk management and disciplined investing, it may earn a place in portfolios seeking asymmetric return profiles to navigate markets today.
I aimed to provide a balanced overview of the benefits and risks of crypto investing, tailored towards beginners exploring allocation in their portfolio. Please let me know if you would like me to expand or modify any part of the blog post. I can refine it further to ensure maximum value for your readers.
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