Six Things Investors Should Know Before Investing in Cryptocurrencies
Investing in cryptocurrencies is considered one of the most lucrative strategies in 2021. As institutional investors and famous people have expressed their love for cryptos, the demand for these digital currencies is skyrocketing, all like their prices. The crypto bull run over the past year has tempted many new investors. However, cryptocurrencies are very volatile assets with a fair share of risk.
Here are the six things you need to understand as a new investor before invest your hard earned money in these digital assets.
1. Don’t take big bets.
I agree that the spectacular returns generated by some cryptos are too enticing. You might want to invest all your money to earn maximum profit in this winning phase. But hold on tight because the crypto markets are nothing short of a roller coaster ride. No one knows if – or when – the market will collapse. Unlike investing in stocks, there is no coverage from the Securities Investor Protection Corporation (SPIC) or the Federal Deposit Insurance Corporation (FDIC) that comes as a savior. Therefore, the gyrations of the crypto markets can be damaging if you take big bets. It is wise to invest only a portion that you can afford to lose.
2. Research well from the start
With a new altcoin seemingly launched every two days, you need to know how to separate quality investments from the equivalent of penny stocks. It is crucial to invest in projects that have been around for some time and have credible support. Look for the authenticity of the developers or the teams that support them. Examine white papers or initial coin offering (ICO) prospectuses. And beware of scammers who most certainly abound during peak periods. If a proposition is too good to be true, it probably is.
Due diligence is essential here. Whenever you are considering investing in crypto in an initial coin offering, you should read the prospectus carefully. It’s a daunting task for sure, but something is worth the effort. In addition to coins, choosing crypto exchanges also requires judgment, especially those that offer more than 100x leverage. It’s okay if a currency gains value, but you could end up losing all your money if it corrects.
3. Invest time in learning the value proposition
Investors who buy a particular cryptocurrency for its rising price are not necessarily a good argument for its value proposition. Unlike stocks, the value of cryptos is not determined by metrics, cash flow, or earnings. Instead, you need to understand the main purpose of each cryptocurrency. Identify the gap they aim to bridge and the factors that make them unique.
For example, replacing gold as a store of value and as an inflation hedge is the best use case for Bitcoin. Ethereum the blockchain serves as the basis for the majority of DeFi (decentralized finance) projects. Likewise, Cardano aims to create an open financial system for inclusive banking. Researching each part’s use cases is the best way to understand what the future holds for them.
4. Diversify your crypto portfolio
Bitcoin is the most talked about cryptocurrency. It has been on a bullish run for a long time, but has fallen since April. So never put all your trust in a single crypto. Instead, you need to diversify your crypto basket to spread the risk evenly. Smart diversification across multiple coins ensures that if one coin is going through a rough patch, the other coins can help you recoup losses. For example, some crypto investors like to follow a 6: 3: 1 strategy which involves investing 60% in Bitcoin, 30% in Ether, and 10% in other altcoins. This ratio varies, however, depending on the investor.
5. Don’t be swayed by emotions
Investing in cryptos should be based on research, not intuition. If fear of missing out is driving your crypto investments, you might be missing out on protecting your wealth. I understand that the hype around crypto, the constant barrage of news, and social media sentiment can be overwhelming. You might just want to follow all the trends. However, it can be extremely dangerous and you could fall prey to overnight scams. Don’t just rely on what others tell you, be they promoters or detractors. Evaluate the merits of the investment case yourself and plan your trips based on the research.
6. Don’t ignore other expenses
It is not uncommon to see multiple price changes in cryptocurrency prices in a single day or hour. Naturally, you might want to take advantage of these changes, but you have to factor in the transaction fees for that. Another factor that you need to check is your taxes. In the United States and Canada, you have to pay capital gains taxes on every transaction. So if you are involved in excessive trading, a significant portion of your winnings can be wiped out if you do not calculate the fees and taxes.
Be prepared for risk and volatility.
Investing in cryptocurrency is exciting and rewarding. But with these profit opportunities come high risks. You could end up incurring losses if you are not sure what you are doing and why you are doing it. Before getting into cryptocurrency, you need to have a high tolerance for risk as volatility is a constant here.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.