The increasing interest, adoption, and investment in cryptocurrency, commonly referred to as crypto, has piqued the curiosity of many investors.
This comprehensive guide aims to provide beginners with a clear understanding of cryptocurrency as an asset class and the basics of investing in it.
By exploring the different types of crypto, factors to consider before investing, and essential details to help you determine its place in your portfolio, this guide will equip you with the necessary knowledge.
Additionally, if you decide that you are ready to embark on your crypto investment journey, you will find a step-by-step guide to help you get started.
Types Of Cryptocurrencies
While the term cryptocurrency broadly encompasses virtual currencies that utilize blockchain technology, there are numerous types available, with over 25,000 recorded as of June 2023, according to CoinMarketCap.com.
Bitcoin, one of the earliest cryptocurrencies, remains the most well-known. All other coin-based cryptocurrencies like Hammer Candlestick or Dogecoin are collectively referred to as “altcoins” or alternatives to Bitcoin.
In recent years, several cryptocurrencies have gained prominence, amassed substantial market value, and attracted a broad user and investor base.
The top ten cryptocurrencies by USD market cap as of June 2023 are Bitcoin, Ethereum, Tether, BNB, USDC (U.S. Dollar Coin), XRP, Cardano, Dogecoin, Solana, and Polygon.
However, it is important to note that the cryptocurrency market is still in its infancy, and many cryptocurrencies are relatively young.
Even though these coins rank among the largest, they are not without risk. The potential for investment losses is real and significant.
For instance, following substantial gains in 2021, the value of most cryptocurrencies experienced a considerable decline in 2022.
Hence, it is crucial to thoroughly research each cryptocurrency before investing and assess whether the investment aligns with your financial goals.
What Is A Decentralized Token, And How Does It Work
Unlike conventional currencies, cryptocurrencies are decentralized, meaning they are not issued, backed, or regulated by a central authority like the U.S. government.
Feldman highlights that this decentralized nature is a crucial feature of cryptocurrency design. These digital units of currency, known as coins or tokens, are created through a validation process that relies on blockchain technology.
Blockchain, also known as distributed ledger technology, generates a secure encrypted record of the value of each virtual coin and its associated transactions.
These records are distributed and linked across a network of parties or computers accessing the blockchain, making it accessible to anyone with an internet connection. The primary objective behind this system is to ensure security, transparency, speed, and accuracy.
What To Consider Before Investing In Cryptocurrency
Cryptocurrency investments can be volatile, with significant price swings occurring within short periods. This aspect might give pause to risk-averse individuals.
It is essential to bear in mind that anyone can create a cryptocurrency, and its regulatory landscape is continuously evolving. Consequently, conducting thorough due diligence to avoid scams is vital.
Before investing in crypto, it is helpful to consider your motivations for doing so. Are you aiming to capitalize on a trend, or do you have a well-thought-out investment strategy in place?
Feldman advises, “Never invest believing that you cannot lose. There is no easy way to make a substantial amount of money without taking risks.
Only invest in a cryptocurrency if you genuinely believe in its long-term prospects and are willing to endure significant price fluctuations.”
Another factor Feldman highlights is the importance of caution and clarity regarding intentions and expectations when investing in cryptocurrency.
Taking a long-term perspective is critical when investing, especially in highly volatile assets like crypto. Emotional decision-making, driven by the fear of missing out or the desire to cut losses, tends to yield poor results.
Therefore, it is essential to adopt sound investment strategies when dealing with highly fluctuating assets.
How Much Should You Invest In Cryptocurrency?
Some experts recommend allocating no more than 1% to 5% of your net worth to cryptocurrency investments.
For example, Feldman suggests that “limiting your overall exposure to crypto is crucial, and it is essential never to invest more than you can afford to lose when determining the appropriate amount to invest in crypto.
While a small exposure to crypto may enhance the risk-adjusted return profile of a diversified portfolio, the specific amount you should invest should be based on your overall investment portfolio and risk tolerance.”
Additionally, diversification within the realm of cryptocurrencies is an aspect worth considering. Feldman explains that “the specific crypto assets you hold matter significantly.
Certain coins may have more promising long-term use cases and be less susceptible to price manipulation.
Although the entire crypto market is highly volatile, there may be less risk associated with larger, more liquid cryptos compared to smaller-cap, more speculative cryptocurrencies.
However, even the largest and most established cryptos exhibit substantial price swings. Therefore, you should carefully consider the mix of cryptocurrencies in your portfolio in addition to the overall amount you invest.”
Stash advises investors to hold no more than 2% of their total portfolio in any one cryptocurrency to mitigate crypto-specific risks.
Pros Of investing In Cryptocurrency
Before 2022, the price of cryptocurrencies exhibited minimal correlation with other investment classes, such as stocks and bonds.
Therefore, having a small exposure to this high-potential growth space could potentially improve risk-adjusted returns.
Although the correlations between cryptocurrencies and other asset classes were high in 2022, it remains uncertain whether this is a new trend.
- Certain cryptocurrencies, such as Bitcoin, have been compared to gold due to their fungibility, durability, scarcity, and lack of dependency on any central authority to define their purchasing power.
- The decentralization and transparency offered by distributed ledgers make it challenging to compromise the network integrity behind cryptocurrencies.
Cons Of Investing In Cryptocurrency
- The cryptocurrency market is highly volatile, and predicting price fluctuations and identifying the drivers behind substantial value swings can be challenging.
- While crypto blockchains are difficult to hack, individuals can be vulnerable to hacking due to the inherent risks associated with any online activity.
- Cryptocurrencies currently have limited government regulation, resulting in transactions lacking legal protection compared to traditional investments like stocks.
