Cryptocurrency – A Beginners Guide
Welcome to the world of cryptocurrencies
Bitcoin is all the rage
So the headlines about Bitcoin, Ethereum and other digital currencies have caught your attention, and now you’re wondering how you can get involved.
Perhaps you are a beginner to investing entirely, but you have decided that cryptos are something you are interested in because the returns look amazing!
This guide will briefly summarise how the cryptocurrency space operates, and how you can start investing in them.
Basic points – what is a cryptocurrency?
Put simply, a cryptocurrency is a form of digital money that is secure and anonymous.
A cryptocurrency is a digital medium of exchange for which encryption techniques are used to regulate its use and generate its release. Encryption is the process of encoding a message or information in such a way that only authorized parties can access it.
Crucially, unlike ‘real’ money – US dollars, euros, pounds and yen for example – cryptocurrency is not regulated or controlled by any bank, government or centralised financial authorities.
Instead, it relies on the power of the internet to guarantee its value and confirm transactions. Users on a network verify every transaction, and those transactions then become a matter of public record. This prevents the same digital currency or coin from being spent twice by the same person.
Cryptocurrencies are unregulated and became popular through allowing people to make transactions anonymously, and are transferred via a peer-to-peer network between individuals, with no middleman bank to take a slice.
All Bitcoin transactions are stored publicly and permanently on the network, which means anyone can see the balance and transactions of any Bitcoin address. However, the identity of the user behind an address remains unknown until information is revealed during a purchase or in other circumstances.
How are coins created?
Digital coins are created through a process called ‘mining’. With Bitcoin, ‘miners’ use special software to solve mathematical problems, and are rewarded with a certain number of Bitcoins in exchange – this is how the coins come into existence.
In the early days of Bitcoin, the mining community was far smaller than it is today. Miners could use their own desktop pc to mine the coin without trouble, but as interest in cryptocurrencies grew, so did the computing requirements they needed to solve the mathematical problem. As demand increased, the supply became more rare, as there is only a finite number of coins in existence. Thus, it became more difficult to discover and mine the coins.
Bitcoins are no longer a good choice for beginning miners who work on a small scale. The current up-front investment and maintenance costs, not to mention the sheer mathematical difficulty of the process, just doesn’t make it profitable for consumer-level hardware. Now, Bitcoin mining is reserved for large-scale operations only.
How many types of cryptocurrency exist?
Thousands, and more and more of them are appearing every day. The vast majority are extremely low in value, especially when compared to Bitcoin, which is considered the king of the crypto market, and many do not last long. Other notable currencies include Ethereum, Dash, Litecoin and Ripple.
In this blog, we will only reference the top coins which most beginners to the marketplace will be interested in investing in, because of the potentially lucrative returns they offer.
How do I actually buy cryptocurrencies?
You can buy them through exchanges, making sure that you first set up a cryptocurrency wallet.
When you buy or receive cryptocurrency, you are given a digital key to the address of that currency. You can use this key to access and validate or approve transactions. You need a place to keep your key safe, which is where a cryptocurrency wallet comes in.
How do wallets work?
A wallet is similar to a bank account in that it is a place where you store your cryptocurrency. Wallets can be held online, or in some cases, in a physical form like a USB stick for extra security.
Once you have a wallet, you have the ability to make purchases on a cryptocurrency exchange.
What’s a cryptocurrency exchange?
Digital currency exchanges are businesses that allow users to trade digital currencies for other assets, such as conventional fiat money, or different digital currencies. A fiat currency is one which is legal tender and backed by a government, like the US Dollar or Japanese Yen.
Some of these platforms allow you to buy your coin of choice directly, while others insist that you buy another coin (like Bitcoin) first, then converting that purchase into the coin of your choosing.
These exchanges generally allow you to buy as much of a coin (or coins) as you would like, akin to fractional share ownership as in the Invstr Portfolio.
You may decide to diversify your purchases of cryptocurrencies, but be aware that other coins can quite often mirror price changes in Bitcoin.
Is it too late to invest?
Not necessarily. While it’s definitely true that those who hopped on the Bitcoin train last year and before that will have seen incredible gains, the future of cryptocurrencies is uncertain, therefore potentially lucrative. Speculators were saying that Bitcoin would never hit $1,000. They said after it hit $1,000 that it would never hit $2,000, and so on and so forth.
Such is the momentum of Bitcoin that $5,000 per coin seems like a distant memory to those keeping an eye on proceedings. Until a catalyst occurs which looks to severely destabilize the marketplace, investors will continue to pour in, while short sellers (bears) feel the burn.
Whether or not to invest depends upon your appetite for risk and whether you are bullish or bearish on the crypto market. If you believe the price is set to move even higher, then by all means invest, but do not base your investment decision on that of the crowds sentiment alone. Conversely, prices could drop substantially, or even go to zero. The bubble could burst, leaving millions of people around the world with nothing to show for their investment.
At Invstr we think sensible investors can have a go at investing in cryptos, so long as they have a wider portfolio to balance out the risk.
Why are digital currencies such a popular investment?
In one word – Profit! Due to the volatility in the marketplace, investing in cryptocurrencies can yield far higher returns than equities or other asset classes, comparatively speaking, but as we’ve previously stated, this is certainly not guaranteed and the opposite could happen.
If we compare the returns on equities to cryptocurrencies for example, the contrast is clear. When we look at some of the top performing stocks on American indices this year and then compare them to Bitcoin, we can see exactly why cryptocurrency trading has become so popular.
The S&P500, the preferred index for US stocks, had an excellent run this year, with many of its top stocks reaping massive gains due to strong corporate earnings, alongside expectations of cuts to tax rates and deregulation in some sectors of the economy. Shares in Nvidia (one of the biggest names in tech) have climbed nearly 200% since Election day in 2016, while Micron Technology (another hot tech stock) had seen its share price rally by over 150% throughout this year. These are excellent results for stocks, underpinned by improving global growth prospects, yet they don’t hold a candle to some major coins.
In comparison, Bitcoin prices have increased by over 1000% this year alone! Even with experts from big banks and funds repeatedly warning investors about a huge bubble in the crypto market that is set to burst, their words have had little effect, with dozens of new crypto-hedge funds entering the market and retail investors piling in.
These kinds of returns are truly unparalleled in mainstream markets, and thus these instruments (or assets) have gained huge amounts of interest.
What are the risks?
As with any asset you choose to invest in, you may not get back the money you put in, but with cryptocurrencies, the stakes are even higher. Bitcoin among others is prone to experiencing huge swings in value in short spaces of time, which can provoke anxiety in some investors.
Investors should also be careful about the prospect of their wallets becoming the target of hackers. In most cases when a bank account is compromised, a customer is protected and can be compensated, but there is no such insurance in the cryptosphere.
We would suggest that you are prudent in your investment strategy and do not be too hasty in joining the crypto-craze, unless you have significant sums of spare income handy. Since Bitcoin, Ethereum, Dash and others experience price rises purely on speculation, investing in them is more akin to gambling, as opposed to investing in equity markets, which usually requires more due diligence on which businesses to invest in. Investing small amounts is a good way to start.
Now that Bitcoin prices are firmly in bubble territory, you really cannot prepare yourself for what may come next. Investing in equities still carries its own type of risk, but less so than cryptocurrencies, especially if you choose reputable, strong and stable blue chip stocks.
With Cryptocurrencies, the fact remains that it is more a case of being lucky, especially when compared to the required analysis of the factors that make a stock, bond or commodity a good investment.
How do I track the performance of a cryptocurrency?
Invstr lets you track the performance of Bitcoin against the US Dollar and Euro inside your watchlist, complete with charts and technical analysis.
For a view of other coins, websites like CoinCap are an excellent resource to see an overview of the marketplace.
It may also help you to track the performance of your coin against other coins, comparing Bitcoin to Ethereum for example.
What will happen next in the crypto space?
Cryptocurrencies are still a relatively new phenomenon, and governments and economists around the world are still struggling to make sense of how digital currencies will affect the world in the future.
Will Bitcoin and other coins become a more broadly accepted and legitimate medium of exchange for everyday transactions globally? Will they begin to greatly undermine regular money and the central banks that control its production?
Some major institutions have moved to take Bitcoin further into the mainstream, by offering crypto derivatives on their marketplaces. CME Group is one such firm. This kind of change in the use of cryptos could lead them to be more heavily regulated, moving them far away from their original purpose of helping people make anonymous transactions.
It also prompts the question over whether policymakers will step in more aggressively to try and control the cryptocurrency market. We just don’t know yet and those are just 2 of the reasons that this asset class could be a risky buy for investors.
There has already been a significant backlash against digital currencies by governments in China and elsewhere. The ruling Communist party in Beijing under Xi Jinping took steps in September this year to shut down noted crypto exchanges and enacted a ban on ICO’s (initial coin offerings). After this, the price went into freefall.
Digital currency news, just like its prices, changes on a day-to-day, or sometimes minute-to-minute basis. This is one of the many reasons why investing in this asset class is not for the faint hearted. With stocks, prices are prone to fluctuate, but nowhere near as dramatically on a day to day basis, as a rule. Keep this in mind when evaluating becoming a crypto investor.
I want to know more
For a more thorough understanding of the crypto world’s beginnings, read our piece – The Institutionalization of Bitcoin.
Want to learn more about the markets and how to become a better investor?
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