Key takeaways
- Digital currencies can fluctuate dramatically, presenting opportunities for significant gains or substantial losses.
- Before putting money into digital currency, conduct thorough research, acknowledge the inherent instability, and only allocate funds you’re prepared to lose.
- Investment options range from direct purchases of digital currency to exploring Bitcoin futures, cryptocurrency ETFs, or stocks of companies involved in cryptocurrency exchanges.
The world of digital currencies is marked by immense price swings. However, for those seeking to invest in this space, these fluctuations can unlock profit-making potential. Coins like Bitcoin and Ethereum have seen considerable growth since their inception, but that journey hasn’t been without considerable ups and downs. Experienced investors have been trading cryptocurrencies for a while now, but what’s the best way for newcomers to enter the digital currency market?
Crucially, before you consider investing in cryptocurrency, you need to get your financial house in order. This means having a financial safety net, manageable debt levels, and ideally, a varied investment portfolio. Think of crypto investments as another element of your broader strategy to potentially enhance your overall returns.
As you begin your cryptocurrency investing journey, keep these five important considerations in mind.
1. Understand what you’re potentially investing in
Just as you would with any investment, take the time to fully understand what you’re putting your money into. If you’re investing in stocks, it’s essential to review the annual report and other regulatory filings to rigorously evaluate the companies. Similarly, you should apply the same scrutiny to cryptocurrencies. With literally thousands of options available, each operates differently, and new ones are constantly emerging. Be sure to grasp the underlying rationale for each investment.
In many cases, digital currencies are not backed by tangible assets or the cash flow of an associated business. This is true of Bitcoin, for example, where investors are relying solely on someone else being prepared to pay more than they did. Unlike a stock, where a company can increase profits and generate returns for you, many crypto assets depend on increased market optimism to deliver gains.
Some of the most well-known digital currencies are Bitcoin, Ethereum, Solana, Dogecoin, and Tether (a stablecoin). So, before you invest, consider the potential advantages and disadvantages. If your investment isn’t backed by an asset or incoming revenue, it could ultimately be valueless.
2. Remember, past performance does not guarantee future results
A common error among new investors is to project past performance onto the future. While it’s true that Bitcoin was once worth very little, it now boasts a much higher valuation. The key question to ask yourself is whether this growth is likely to continue, even if at a more moderate pace.
Forward-looking investors focus on what’s ahead, not what has already happened. The crucial point is what will drive future returns. Investors acquiring cryptocurrency today are seeking future gains, not simply a reflection of past performance.
3. Expect high volatility
Cryptocurrency prices are among the most unpredictable of any asset class. Values can plummet in an instant based on nothing more than a rumor, regardless of whether there’s any truth to it. This can be a good opportunity for experienced investors who can react quickly or possess a deep understanding of market fundamentals, current trends, and potential future movements. However, for new investors without such expertise—or the advanced algorithms that drive rapid trading—it’s a hazardous environment.
Volatility is a game played by powerful traders on Wall Street, each trying to outmaneuver other investors with significant resources. New investors, or those with a lower tolerance for risk, can easily find themselves overwhelmed and make rash decisions.
Because volatility often shakes out traders, particularly beginners, who become easily frightened. Meanwhile, more seasoned traders may seize the opportunity to buy at lower prices. In essence, volatility can help experienced traders “buy low and sell high,” while inexperienced investors tend to “buy high and sell low.”
4. Manage your risk carefully
When trading any asset in the short term, you must manage your risk exposure, particularly with volatile assets like cryptocurrency. As a novice investor, you’ll need to learn the best techniques to manage risk and establish procedures to help minimize losses. These procedures can vary depending on individual preferences:
- Long-term investors might choose a strategy of never selling, regardless of price fluctuations. This long-term view enables the investor to maintain their position.
- Short-term traders, however, might implement specific rules about when to sell, for example, when an investment declines by 10%. Strictly adhering to this rule prevents relatively small losses from growing into much larger problems.
New traders should think about setting aside a specific amount of trading capital and initially using only a portion of it. If a position moves against them, they’ll still have money available for future trades. The underlying principle is that trading requires capital. Maintaining cash reserves ensures that you always have funds available for trading activities.
Managing risk is crucial, but it can also bring emotional challenges. Selling a losing position is never easy, but it can prevent potentially larger losses down the road.
5. Don’t invest more than you can afford to lose
It’s crucial to avoid allocating essential funds to speculative assets. If you can’t afford to lose it all, you shouldn’t be investing in risky assets like cryptocurrency, or any other speculative investment, for that matter.
Whether it’s a down payment on a home or an upcoming major expense, funds needed within the next few years should be kept in secure accounts to ensure they’re available when required. If you’re seeking a guaranteed return, your best bet is to pay down high-interest debt. This effectively guarantees a return equivalent to the interest rate you’re currently paying, ensuring no losses.
Also, consider the security of any exchange or brokerage you use. While you may legally own the assets, they need to be properly protected. If you question the security measures of a particular provider, some traders choose to invest in a digital wallet to hold their coins offline, safeguarding them from hackers.
Remember that cryptocurrency investing can form part of a broader investment strategy, but it shouldn’t be your only focus.
Other ways to invest in cryptocurrency
While direct cryptocurrency investment is popular, there are alternative methods for investors to participate in the crypto market, varying in terms of directness.
- Crypto futures: Futures provide another way to speculate on Bitcoin price fluctuations, and they also allow the use of leverage to boost potential returns or losses. Futures trading is a fast-paced market that can magnify the already considerable volatility of cryptocurrencies.
- Bitcoin or Ethereum ETFs: Spot Bitcoin and Ethereum ETFs are readily available through the vast majority of online brokers who provide traditional investments such as stocks and bonds. These ETFs offer an accessible way to invest in crypto through a fund-like structure. (Find the best Ethereum and Bitcoin ETFs.)
- Crypto exchange or broker stocks: An alternative approach is to invest in companies positioned to benefit from the expansion of the cryptocurrency market, irrespective of which currency emerges as dominant. This strategy could include investing in exchanges like Coinbase or brokerages like Robinhood, which generate a significant portion of their revenue from cryptocurrency trading.
- Blockchain ETFs: A blockchain ETF gives you exposure to companies that may benefit from the emergence of blockchain technology. The leading blockchain ETFs offer exposure to some of the most prominent publicly traded companies in this space. However, it is important to note that these companies often have operations beyond those connected to cryptocurrency, meaning your exposure is diluted, affecting your potential returns and losses.
Each of these approaches comes with different levels of risk and exposure to cryptocurrency, so it’s crucial to understand what you’re buying and whether it aligns with your investment goals.