If you have landed on this page, it is probably because someone in your network is making huge profits with crypto. Or you are an investor who is looking to diversify your portfolio. Maybe both.
I have been in your place. Confused about how cryptocurrencies work, the technology behind them, and questioning if it is truly decentralized. If I invest, how much, where, and from which coin should I start? Most important of all, is it safe to invest?
I have structured this article as a learning path to help you take your first step in adopting cryptocurrency as an investment:
- What is Cryptocurrency?
- Difference Between Bitcoin & Ethereum
- How is Investing in Cryptocurrency Different From Trading?
- Key Elements Required For Cryptocurrency Transactions
- How To Research Which Cryptocurrency To Invest In?
- Which Exchange Platform To Choose? Centralized v.s. Decentralized
- 4 Safety Measures To Take Before You Start Investing In Crypto
- Steps to Buy Cryptocurrency on a Centralized Exchange
- Steps to Buy Cryptocurrency on a Decentralized Exchange
- Do I Have to Pay Taxes On Crypto Investments?
- Crypto Investment Mistakes To Avoid As A Beginner
- Risks Involved in Cryptocurrency Investments
What is Cryptocurrency?
Cryptocurrency can simply be described as digital money. A decentralized public ledger records all cryptocurrency transactions using blockchain technology and cryptography. The ledger is accessible by everyone, which is why it is called as a “public ledger”.
In our current financial system, a central authority like the central bank facilitates all our transactions. However, all cryptocurrency transactions are validated and verified by a group of people/nodes who don’t know each other, are geographically distributed and participate purely for the incentives that a particular cryptocurrency has to offer. Hence it is called as a “decentralized system”.
To learn about how cryptocurrency works using blockchain technology, and what gives value to it, read our ‘Beginners Guide to Cryptocurrency‘.
Difference Between Bitcoin & Ethereum
Bitcoin is the first cryptocurrency to come into existence. It has been nearly 11 years since it was launched and is currently the world’s largest cryptocurrency by market capitalization. It is used as a store of value and a mode of payment.
However, ethereum is not just a mode of payment. Businesses from various sectors develop financial contracts and applications on the ethereum blockchain. These applications issue their own cryptocurrency tokens for users to use the application.
How Is Investing In Cryptocurrency Different From Trading?
Cryptocurrency Investment is the act of purchasing a crypto asset, with the hope that it will increase in value over a period of time. Investors own the crypto they buy and can make profits only in the long-term. They conduct a research on fundamental factors of a cryptocurrency project – project team, whitepaper, tokenomics, market capital, maximum supply, etc.., to decide which cryptocurrencies to invest in.
Whereas, cryptocurrency trading involves conducting technical analysis where periodic trends are studied and analyzed across various time frames. Based on the analysis findings, traders will speculate on the price movements of a crypto asset by taking long or short positions:
- Long Position: When traders speculate an increase in the price of a cryptoasset within a specified period, they buy crypto and wait till the price increases to sell it and make profits.
- Short Position: When traders speculate a decline in the price of a cryptoasset within a short period, they sell crypto. Once the price declines, they buy their crypto back at a lower price, making profits.
If prices go against a trader’s speculations, they will incur losses. Some traders utilize margin & leverage to borrow huge amounts of capital to take long or short positions.
To conclude, crypto trading needs more risk management and if traded without technical analysis, it will lead to losses. Investing in certain cryptocurrencies need thorough research on their fundamental factors to keep yourself safe from any scams, or devaluation of a coin/token.
Key Elements Required For Cryptocurrency Transactions
You got to trade a coin or token in a cryptocurrency exchange and hold them in your crypto wallet. Let’s see what each of them actually means:
- Any cryptocurrency running on its own blockchain network is called as a cryptocurrency coin
- Coins can be mined & stored in digital wallets or used as a form of currency to buy/sell items
- Value of coin depends on its supply & demand.
- Any application built on top of a blockchain (like bitcoin, ethereum, solana), issue a token for users to use the application.
- These tokens represent assets like digital art, docs, certificates, real-estate, etc.
- Value of a token is based on how useful it is.
- Once you have chosen which coin or token you want to invest in, you need an online platform where you buy, sell or trade cryptocurrencies. This platform known as “cryptocurrency exchange” acts as a marketplace for crypto assets.
- There are two types of exchanges. Centralized & Decentralized.
It is a Digital wallet which stores cryptocurrency coins and tokens. Similar to a physical wallet in which you hold your cash, digital wallets are on your phone or browser as an app or extension respectively. There are two types of wallets:
- Hot Wallet: is connected to the internet. Examples: Exchange Wallet (a wallet created when you open an account on a centralized exchange), Desktop Wallet or Mobile Wallet
- Cold Wallet: isn’t connected to the internet. You can connect it to the internet only when you need to make a transaction. Example: Hardware Wallet or Paper Wallet
It is 25–30 alphanumeric characters that represents the address of your wallet. You can share it with others to receive cryptocurrency into your wallet.
It is also a set of alphanumeric characters. But, this key allows you to access your funds. If you forget your private key and haven’t recorded it anywhere, you will lose access to all your crypto funds. The key shouldn’t be shared with anyone. (Note: On centralized exchanges, the exchange company will maintain your private key for you).
How To Research Which Cryptocurrency To Invest In?
This article is purely for educational and informational purpose and not to encourage you to buy cryptocurrency. You should always do your own research (DYOR), make your own decisions (MYOD) and be comfortable with the risks before making an investment. Investing in volatile cryptocurrencies involves an element of risk: prices of these currencies go up and down, (often in a manner that seems irrational).
We often buy products by comparing their prices. Similarly, some beginners in the crypto space, often compare prices of cryptocurrencies to decide which one to buy. Some buy a cryptocurrency only because a public figure or a community is talking about it.
Novice crypto investors are usually recommended to start with the world’s largest cryptocurrencies by market capital – bitcoin and ethereum. They are both extremely volatile. But what makes them more reliable compared to others, is the period of time for which they have withstood the storm of attacks and manipulations in their blockchains. In addition to that, it is easier to buy and sell bitcoin because it has the highest liquidity compared to other coins. After starting with these, you could then explore other coins or tokens that solve specific problems.
Before you invest, it is very important that you do your own research to decide which cryptocurrencies to invest in. It will not only help you to beware of scams, but to also develop a sense of confidence when you invest. But, what to research?
1. Project’s Whitepaper:
Every cryptocurrency project is created to solve a problem. The project’s whitepaper provides an overview of the technology on which it is built, what problem it solves, features and upgrades. Read the white paper of any cryptocurrency that you want to invest in. It will help you understand what value the cryptocurrency is bringing to the whole eco-system. On the other hand, if a whitepaper fails to convey it’s value or does not have realistic goals, then it is probably not a cryptocurrency you should invest it.
2. Project’s Team:
It is very crucial that you check for the credibility of the team that is working on the cryptocurrency project. One way of checking is to just google their names & find their Linkedin or Twitter profiles. Go through it. Check if they have ever built or worked for a renowned firm before? Have any other credible people in the crypto space supported/endorsed them? How often do they talk about the progress of their project or about the industry? This will help you establish a little bit of sense of security that your money is in safe hands.
3. Supply & Market Capital:
Some crypto coins are cheaper because their supply is significantly larger. Let’s understand this better by comparing two cryptocurrencies in real-time – XRP and Bitcoin
As you can see from the table, XRP’s circulating supply is larger than that of BTC. But, it’s market capital is lower. Which is why the price of XRP is cheaper than BTC.
Now, for $XRP to reach a price target of say $45,000, it’s market capital should approximately increase by 51,098 times! That would be more than quadrillions of dollars!! which is near to impossible.
You may now ask ‘Does this mean I shouldn’t invest in cheaper crypto?’
No, you may invest in crypto that’s cheaper in price. But, don’t invest all your money in it. Diversify your crypto portfolio. Invest in cryptocurrencies whose value you believe in. Decide the ratio of your diversification by comparing their market capital & supply.
You can find all the listed cryptocurrency coins and tokens on coinmarketcap.com
4. Staying up-to-date with the industry:
Get on twitter & subreddits. Be curious and spend some time on these channels. Follow personalities who are active in the industry. Discover new coins. The more you read, the better you will understand how cryptocurrency & blockchain technology can change the way our financial systems work. It will help you develop a sense of belief in the system.
Which Exchange Platform To Choose? Centralized v.s. Decentralized
Exchange Platforms have been critical to the success and widespread adoption of cryptocurrencies. However, users face confusion about which exchange type to use. At the moment, there are two types of exchanges:
- Centralized Exchange (CeX): Cryptocurrencies are decentralized in nature. However, most of the buying and selling activities of cryptocurrency takes place on centralized exchanges. It acts as a middle man who is entering our transactions into the cryptocurrency network for us.
- Decentralized Exchange (DeX): are complete opposite of centralized exchanges. There is no middle man. Transactions are automatically facilitated by matching buyers with sellers, using smart contracts that are built on the ethereum blockchain. For example: Adam wants to buy bitcoin at $10, and Mary wants to sell her bitcoin at $10. They request it on the exchange. Smart contracts match them and the transaction is done!
Each have their own sets of advantages & disadvantages. Let’s compare them before concluding which platform to use:
a. Sign-up Process:
CeX: You have to sign-up & make an account on the exchange to buy crypto. In the process, there will be KYC (Know Your Customer) procedures.
DeX: No sign-up process. You just have to download a wallet & connect it to a DeX only when buying or selling crypto assets.
CeX: creates an exchange wallet when you sign up. The wallet’s private key is with the exchange. So, you don’t have complete control over your crypto assets.
DeX: You have complete ownership of your private key, wallets and crypto assets. But, if you lose your private key, you will lose access to your funds.
CeX: Transaction requests can be tracked on blockchain. However, reserves cannot be publicly verified.
DeX: All transactions are publicly viewable & is fully transparent.
CeX: Crypto can be bought using fiat currency on the platform. It has a easy user experience and customer support team that we can reach out to, incase of any mishaps.
DeX: You need to have Ether or stable coins like USDC to buy crypto assets on the exchange. It takes time to get familiar with using the platform. There is zero customer support.
CeX: Has higher liquidity because large number of users make buy/sell orders according to market trends. Orders are tracked & matched in an order book.
DeX: There is no order-book system. You may have to pay higher prices if there isn’t enough liquidity on pairs you want to trade.
CeX: Charges a % of trading fee per transaction, depending on the platform
DeX: When placing a transaction, users pay a ‘gas fee’ to confirm their trade on DeX. It could start from as low as $0.01 & could go significantly higher when a blockchain gets more traffic
CeX: lists only verified coins/tokens on their platform. Governments regulate centralized exchanges for customer protection. In case of hacks, depending on it’s nature, a widely known exchange can refund some funds.
DeX: Non-verified/Scam tokens could be listed on DeX. There is zero consumer protection. It isn’t suitable for retail customers.
Conclusion: Experts recommend beginners to start with a centralized exchange because of it’s ease of use. Give yourself some time and get first-hand experience on how the cryptocurrency market works, by buying and selling on centralized exchanges. Understand the risks involved. Once you develop confidence with investing in cyrpto, start reading about DeFi projects and different types of wallets. That will help you decide which DeFi coins/tokens you want to invest in. Then you can choose a decentralized exchange integrated with the DeFi token you want to invest in, and start investing.
4 Safety Measures To Take Before You Start Investing in Crypto:
1. Bookmark the correct cryptocurrency website links:
Some hackers create fake websites to collect your login credentials and hack your accounts. Therefore, it is important to ensure that you are accessing the right website URL’s. You can cross-check some of the website URL’s with exchange tokens that are listed on http://coinmarketcap.com. Also ensure that the website has a ‘HTTPS’ protocol. This ensures that the website has a Secure Sockets Layer (SSL). An SSL protects user’s information which passes through the website.
2. Two Factor Authentication for your exchange wallets using Google Authenticator:
2-Step Verification (also known as 2FA or two-factor authentication) adds an extra layer of security to your wallet. You’ll need both your wallet password and a one-time passcode (OTP) created by the Google Authenticator App to log in. It is more secure than SMS because it is offline and local to your device. It does not require an internet connection or phone service.
3. Set up a pass-phrase with your cell phone provider:
Hackers steal your SIM by requesting your cell phone provider to provide a new SIM card. If they get access to your SIM card, they can access your accounts. To prevent this, set up a passphrase with your cell phone provider, which must be disclosed before activating a new SIM card.
4. Download a Key Scrambler:
This tool will encrypt everything you type in real-time, in order to prevent malware from recording your keystrokes that will allow them to hack your account/wallets.
Wohooo, now that you have taken a few safety measures, let’s dive into the process of how you can actually buy cryptocurrency on a centralized and decentralized exchange.
Steps to Buy Cryptocurrencies on a Centralized Exchange
When you buy crypto for the first time, you have to buy it through your fiat money, on a centralized exchange. Follow the below steps to do so:
- Identify a centralized exchange that accepts your national fiat currency. When choosing an exchange, ask the following questions: Is their website safe to use? Do they have a licence? How safe are your funds? Who are the executives in charge? Where is the headquarters?
- Create an account on the exchange and verify your account according to the KYC requirements.
- Once verified, choose a payment method to send fiat money from your bank to your exchange wallet through direct deposit, e-transfer or your credit card. These options vary with every exchange. When choosing a payment method, consider factors such as fees associated and limits allowed to transfer.
- Do you research, check the prices and buy any cryptocurrency of your choice.
(Optional) After buying crypto, if you plan on holding it for long-term, transfer your crypto assets to a hardware wallet. This is just a safety measure to protect your crypto assets from any hacks.
Steps to Buy Cryptocurrencies on a Decentralized Exchange
Decentralized exchanges require you to have Ether or stable coins like USDC to buy crypto. Ether or stable coins can be bought on a centralized exchange (see above). Once you have Ether or stable coins in your centralized exchange wallet, follow the steps below:
- Download and set up a hot wallet extension like Metamask or TrustWallet. Note down your passphrase on a paper and keep somewhere safe and secure.
- To fund your hot wallet, transfer crypto from the wallet on your centralized exchange to your hot wallet.
- Research and choose a blockchain ecosystem that you want to invest in. (i.e., Ethereum, Polygon, Binance Smart Chain)
- Choose a decentralized exchange that has the liquidity and crypto assets that you want to buy on a blockchain ecosystem.
- Connect your hot wallet to the decentralized exchange and start buying the crypto assets you want with Ether or Stable coins.
(Optional) After buying crypto, if you plan on holding it for long-term, transfer your crypto assets to a hardware wallet. This is just a safety measure to protect your crypto assets from any hacks.
Do I Have to Pay Taxes On Crypto Investments?
In most countries, cryptocurrencies are taxable. How they are taxed depends on regional and national regulators. In United States, United Kingdom & Australia, crypto investors & traders pay capital gains tax or income tax on crypto activities.
Due to the ever-changing crypto landscape and growing adoption of cryptocurrency as an investment, tax regulations are also developing. You have to stay up-to-date with them to avoid penalties. Here are 4 factors you should know about to meet your tax obligations & avoid penalties for nonpayment:
- Which crypto activities are taxable?
- What is the source of your crypto income?
- When did you buy a coin, when did you sell it? What is the profit/loss amount?
- Which software should you use for tracking & calculating your crypto taxes?
Read in detail here: https://bear.tax/blog/crypto-tax-reporting/
Crypto Investment Mistakes That Every Beginner Makes
1. Buying high & selling low:
As a beginner, without our conscious, we make investments based on our emotions. There’s a little bit of trading psychology that’s involved here. When prices of a cryptocurrency increases, we start experiencing FOMO (fear of missing out) on making huge profits. So, we end up buying our crypto assets when prices are high. And when prices start declining, we fear making losses. So, we start selling our crypto assets. That’s why it’s important to understand that cryptocurrencies are highly volatile. Prices are falling & rising in seconds!
So when to invest then?
Use a method called dollar cost average. In this method, you buy a fixed amount of crypto at regular intervals (weekly/monthly), without giving much thought on prices. For example: Assume that you have allotted $1200 for investing in bitcoin. Divide this $1200 over 12 months. Every month, at any point, buy bitcoins worth $100.
2. No portfolio diversification:
Even when you allot some portion of your portfolio for crypto investments, diversify your crypto investments as well. Instead of investing in one cryptocurrency, you might want to invest in a few other cryptocurrency just to protect yourself from adverse circumstances. Plus, some cryptocurrencies may have the potential to outperform others.
For example: Instead of investing $1000 in Bitcoin, you can invest $500 in Bitcoin and $500 in Ethereum. They both have the largest market capitalization and longest price history as well. This is a very good ratio for beginners to start with.
3. Buying more than you can afford to lose:
Stock prices change with a company’s performance. But most cryptocurrencies’ prices aren’t tied to anything specific. This makes it difficult to predict their future value. So, experts recommend to allocate only a small portion of your total investment portfolio for crypto. If you are saving up to buy a house, repay debts or education loans, don’t use that money to invest in crypto in the hopes of doubling it faster. You may lose all your money. Figure out an amount that you can truly afford and stick with it. Be patient with the process.
Risks Involved in Cryptocurrency Investments:
- Speculation increases volatility: The price of cryptocurrencies is fueled by more people trusting and believing in the system, in addition to how we respond to speculative activities. Example of speculative activity: Elon Musk tweets about bitcoin. People respond to it by buying bitcoin because he is buying. Due to limited bitcoin supply, when demand increased, prices also skyrocketed. On the other hand, if demand declines rapidly, a coin may lose all of its value in less than a day!
- If there is not enough liquidity (no. of buyers and sellers), you may not be able to sell your cryptocurrency easily.
- Cryptocurrencies may not be regulated in your country of residence. This may restrict/limit how you use your crypto. If you don’t know about the rules and regulations in your country, you may land yourself in trouble.
- The exchange platform you have your wallets in, can get hacked, shutdown, or have restricted access due to regulation. In this case, here’s what you can do
- If you don’t take safety measures, your account might get hacked. You’ll lose all your funds.
Now that you know how to research and choose crypto coins or tokens that you want to invest in, how you can buy them, mistakes you should avoid, and risks involved, you are all set to start your journey!
If you have any questions, drop them in the comments 🙂