How To Invest In Cryptocurrency: 6 Steps
Investors wanting to know how to invest in cryptocurrency should understand how the digital currency works, investigate the various crypto investment options, and evaluate the risks before buying. For investors who have done the research and are interested in pursuing a potential investment in crypto, this report outlines the steps to do it.
Cryptocurrency Investing Basics
Cryptocurrency is a digital currency that shares the same general purpose as physical currency, which is to act as a medium of exchange. Although people can use cryptocurrency to pay for goods and services, the digital currency is more commonly known as a speculative type of investment asset.
Also known as "crypto," cryptocurrency uses blockchain technology to record transactions in a ledger system. A distinguishing feature of this technology is that it prevents cryptocurrency from being manipulated or controlled by any single entity. This important aspect of crypto provides for secure online transactions and makes the digital currency nearly impossible to counterfeit.
6 Steps to Invest in Cryptocurrency
Note: This report is not a recommendation to purchase any of the various forms of digital currency. For investors who are interested in pursuing a potential investment in cryptocurrency, the following steps may be helpful.
1. Evaluate Your Cryptocurrency Options
There are thousands of cryptocurrencies that are publicly traded today, and others continue to come on the market. Examples of popular, more widely traded cryptocurrencies include Bitcoin (BTC-USD), or altcoin options, such as Ethereum (ETH-USD), Litecoin (LTC-USD), and Solana (SOL-USD).
Crypto ETFs that offer indirect exposure to cryptocurrency are also available on the market, such as ProShares Bitcoin Strategy ETF (BITO), which is the first exchange-traded fund to track the price of Bitcoin. Currently, the SEC has only approved crypto ETFs that do not directly hold Bitcoin. Instead, they own futures contracts, which enable the fund to gain exposure to Bitcoin prices without taking possession of the cryptocurrency. Futures contracts expire, which means that the ETF will have to roll these futures contracts into later maturities. This exposes the fund to rollover risk, notably when the futures curve is upward sloping.
Tip: Alternative cryptocurrencies to the widely traded Bitcoin are commonly referred to as 'altcoin' in the cryptocurrency investment community. Since Bitcoin is so widely traded and well known, alternative coins to follow, or altcoins, generally refer to any cryptos other than BTC.
2. Learn How the Cryptocurrency is Managed
Some of the more popular forms of cryptocurrency, such as Bitcoin, use mining to generate new units and are built on their own blockchain. Like Bitcoin, some digital currencies have a limited supply of coins, which can create demand and support their perceived value. For example, Bitcoin supply is capped at 21 million.
Most altcoins are produced in the same way as Bitcoin and share similar characteristics. However, some altcoins may use a different process to produce and validate blocks of transactions. For example, Ether is the cryptocurrency of the Ethereum network, which uses decentralized applications, or "dapps," to create contracts that automatically enforce their clauses.
3. Understand Crypto "Fundamentals"
Fundamental analysis for cryptocurrency is not exactly the same as the traditional approach of measuring the intrinsic value of a business. However, investors can analyze certain crypto valuation metrics, such as market cap, trading volume, hash rate, number of active addresses, and transaction value and fees.
Some common crypto valuation metrics include:
- Market capitalization: Also known as network value, the crypto market cap is calculated by multiplying the total number of coins that have been mined by the current price of a cryptocurrency coin.
- Trading volume: Crypto trading volume is a measure of the number of coins that have been exchanged during a given trading day.
- Hash rate: Used on Proof of Work (PoW) cryptos like Bitcoin and Ethereum, the hash rate is a measure of efficiency in mining coins and processing transactions. Thus, a crypto's hash rate can be used in assessing the strength of a blockchain network.
- Active addresses: This metric measures the blockchain addresses that are active in a given period of time. A simple method to calculate active addresses for a cryptocurrency is to total the number of sending and receiving addresses over various periods, such as days, weeks, or months, and analyze the activity to assess the interest in a given cryptocurrency.
- Transaction fees: Miners get financially rewarded for the large amount of computing power and energy required to support a cryptocurrency network. The cost to mine cryptocurrency tends to increase over time; therefore, it follows that fees would need to rise to compensate miners and that analyzing fees paid over various periods can help investors assess the security or stability of a given cryptocurrency.
Important: Investors should note that multiple crypto valuation metrics should be considered together and not in isolation. For example, crypto market cap, without a broader value proposition, may not be useful in assessing the intrinsic value of a cryptocurrency. But market cap coupled with trading volume can be more useful. It's also important to compare metrics of one cryptocurrency with its competitors.
4. Select An Exchange or Broker & Register
Investors wanting to invest in cryptocurrency can begin with the selection of a cryptocurrency exchange or a brokerage firm that allows cryptocurrency trading. Examples include Coinbase (COIN), which is a cryptocurrency exchange, and Robinhood (HOOD), which is a discount broker that allows the trading of cryptocurrency.
When selecting a crypto exchange or broker, investors will need to consider the kinds of cryptocurrencies available for purchase and the fees associated. Fees for trading crypto vary, but most exchanges charge between 0.1% to 1% or more per trade.
5. Purchase Your Cryptocurrency
Some of the major cryptocurrencies, such as Bitcoin, are available for purchase with U.S. dollars, while others require that investors pay with Bitcoins or another cryptocurrency. When investors buy coins from cryptocurrency exchanges or brokers, it's typically stored in a custodial wallet.
6. Store Your Cryptocurrency Investment
To buy and store crypto, investors generally need a wallet, which is an online app that stores cryptocurrency. Many exchanges and brokers offer wallet services to their users. Investors wanting to store cryptocurrency themselves can transfer it to their own hot wallet or cold wallet. The primary difference between hot and cold wallets is that hot wallets are connected to the internet and cold wallets are not.
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