Beginner’s Guide To Cryptocurrency Investing

This is an introduction to cryptocurrency investing for people who are interested in cryptocurrency but aren’t sure what they need to do to get started. Please note, I am not a financial advisor and nothing you read here should be taken as investment advice.

What is cryptocurrency?

To put it simply, cryptocurrencies are digital tokens which are cryptographically secured (hence “crypto”) and allow users to transfer value between themselves (hence “currency”) without the use of a third-party intermediary such as Visa.

Different cryptocurrencies are good at different things. Bitcoin has established it’s purpose as a “Store of Value”, a currency that’s free from manipulation by central governments who are able to manipulate and dilute the value of their own currencies by printing more of it. Unlike the U.S. dollar which can be created or destroyed at will and in unlimited quantities, Bitcoin adheres to a strict monetary policy: 6.25 Bitcoin are mined every 10 minutes, and that amount is cut in half roughly every 4 years until the maximum 21 million bitcoin are created. Nobody controls the network and nobody can change the rules; on the contrary, all network participants are bound to play by the same ones.

Ethereum is another well-known example of a cryptocurrency. Ethereum is a platform that allows developers to create what are known as dApps — decentralized applications. As the name suggests, dApps are applications which don’t have a central authority in control of them. Often these dApps are cryptocurrencies of their own. Current implementations of dApps allow for decentralized banking in the form of lending and borrowing money, trading stocks and other real-world assets, and even “tokenizing” ownership of those assets. We will look into dApps in a separate article because there is a lot to cover and not enough space here, but Ethereum basically allows anyone with a little coding knowledge and a dream to create their own cryptocurrency. The reason it has value is because every time a dApp created on the Ethereum network is used, they must pay a fee (called gas) which is charged in ETH. Like Bitcoin, ETH can also be used as a currency and functions as a store of value (though, arguably, not as well as Bitcoin).

There are thousands of other cryptocurrencies on the market today, many of which trying to find their own purpose in the digital world (VeChain) and others trying to improve on what has already been created by older, less efficient cryptocurrencies (Cardano, Polkadot, Solana). The market is still young and thus the room for improvement and innovation is almost limitless.

What are the risks?

The main risk of cryptocurrency investing is that the market is very volatile. Everyone is aware of Bitcoin’s infamous rise in 2017 from $900 to $20,000 at the end of the year, followed by a rapid pullback below $4,000. Seeing your investment rise and fall so dramatically is too difficult for most people to handle.

Thankfully, as the market continues to grow, these price swings won’t be as severe. However, the reason you can get asymmetric returns today (I.E. what you get out is much higher than what you put in) in cryptocurrency is because of this risk. Once the market is mature, universally accepted, and established, it’s unlikely people will be able to invest a few thousand dollars and cash out for Lamborghinis as commonly as they do today. Successful cryptocurrencies will have found their ideal market prices and unsuccessful ones will have become irrelevant. Right now the market is still young and undervalued so this is the best time to establish a position inside it.

The other risk to consider is that governments and regulators haven’t been able to fully address the idea of digital currency. It seems that most of them are willing to accept it, but even as recently as February 2021, India banned the private use and collection of cryptocurrency in their country. It seems governments around the world are still going back and forth between the idea and while it seems most are welcoming the innovation, the future is not yet clear. XRP, for example, has been sued by the SEC and the debate over whether it should be classified as a cryptocurrency or a security is ongoing. Will XRP be the only currency to suffer this fate? Only time will tell.

Where to Invest.

If you’ve made it this far and you’re not frightened by the possibility of losing a lot of money and the fact that the regulation of this is still being ironed out, here is how you get started.

Finding a cryptocurrency exchange.

Your first purchase of cryptocurrency should be from an actual cryptocurrency exchange. The issue with buying cryptocurrency with apps like Robinhood, PayPal, or CashApp, is that while they allow you to invest in cryptocurrency, they do not give you actual ownership of it. When I buy cryptocurrency, I want to have the ability to hold it myself, transfer it to another wallet, or actually use it. If you buy from Robinhood, you can’t transfer your coins to another wallet or exchange. Even if you sold your cryptocurrency for dollars and then purchased the same amount on an actual exchange later, you’d still be subject to paying capital gains tax since you sold it first. The whole purpose of cryptocurrency is the ability to transfer value without relying on a central authority, and buying from either of the three companies mentioned above will not help you accomplish that.

If you live inside the United States, the most popular and accessible cryptocurrency exchange is Coinbase. If you’ve never used an exchange before, Coinbase is a great option because it’s secure and easy to use. They also have a large variety of cryptocurrencies for you to choose from and you can access it from your phone, computer, or tablet.

Note: Once you become more advanced, I’d recommend using an exchange like Binance.US for an expanded range of options and lower exchange fees. Other recommended exchanges are: Voyager, Celsius, Kraken, or Gemini (if you live in NYC).

Signing up for an account.

The sign up process for each exchange will vary, but they should all be able to guide you through. Basically you’ll enter your personal information so they can verify your identity and create your account. Be prepared, you may be required to upload a photo of your driver’s license and take a selfie. Most exchanges must follow federal “Know Your Customer” requirements in the United States to prevent money laundering or illegal activity, so while this is unpleasant, it’s also the law.

Once the account is established, you’re well on your way to purchasing your first cryptocurrency.

Investment strategy.

I don’t want to tell you which cryptocurrencies you should buy. More so, I’d like to provide you with an investment framework that has worked for me and has allowed me to to make great returns on my money while minimizing my risk.

Be aware, cryptocurrency is in a “bull market” right now, so there are projects which are taking off that have no fundamental value whatsoever, just because there’s so much money flowing around in the market. Doge Coin is an excellent example of this. You can try your luck chasing those projects and riding the wave, but the smarter option is invest where there is value. Eventually, we will be in a bear market again, and the projects that aren’t worth their salt will not weather the storm, but the strong ones will survive to see the light of day and continue to prosper.

Understanding Market Cap.

The market cap of a cryptocurrency is the total value of the network based on the price of a single coin and the total number of coins in circulation. The formula is simple: (Price per coin X circulating supply).

For example, at the time of writing, Bitcoin is trading for $38,600 per BTC. There are 18.6 million Bitcoin in circulation, which makes it’s market cap roughly $722 Billion dollars ($38,600 x 18,621,725).

Bitcoin currently has the highest market cap of all cryptocurrencies by far, coming in over $500 Billion dollars higher than the closest competitor (Ethereum). In fact, it’s larger than the rest of them combined.

You can view the current rankings of cryptocurrencies by market cap on coinmarketcap.com.

A high market cap shows strength and durability, which is good. However, for the price of a coin to double, it would mean the market cap would also need to double. In order for Bitcoin to go from $38k to $76k per coin, for example, it’s market cap would need to grow another $722 billion dollars, for a total of $1.4 Trillion.

For Ethereum to double, the market cap would only need to grow another $186k, which is a much easier feat. To put that into perspective, if Ethereum’s market cap grew by the $722 billion required for Bitcoin to double, Ethereum could almost quintuple in value for the same amount.

If you think of market caps as boats on the ocean, Bitcoin would be like a Navy Carrier; strong and durable, and nothing short of a tsunami or a glacier is going to move it. Ethereum would be, perhaps, a Navy class Destroyer. Still massive, but faster and more agile than the Carrier. Then as you proceed your way down the list you get to small speed boats which can move very quickly but are much more vulnerable to the waves.

The lower a coin’s market cap, the riskier of an investment it is. Depending on your risk threshold, the “safest” investments you can make will likely fall within the top 30 of the list.

Venturing further than that exposes you to increasingly riskier assets, which means your probability of losing money increases, but so does your odds of making huge asymmetric gains. Buying an asset while it’s at a $50 million dollar market cap allows you to buy a large portion of coins on the network without spending a tremendous amount of money, and if it happened to become successful and the value of the network rises to a few billion dollars or beyond, you’ll make out very handsomely for that investment.

Build your portfolio with risk in mind. The largest allocation of your capital should be put towards safer projects with higher market caps because they’re in demand and less likely to fail. Keep a smaller allocation, maybe 10% to 30% depending on your tolerance, for projects with lower market caps. Remember, getting rich is the goal, but not losing money is always the first priority. You can’t get rich if you get liquidated first.

Fundamental Analysis: Identifying Winning Projects.

Once you understand market cap and the implied risks, the next step is to start choosing cryptocurrencies to invest in. As you’ve likely learned by now, everyone and their mother (sometimes literally) will have a project to pitch you on.

Your job as an investor is to separate the wheat from the chaff.

Before investing into anything, please make sure to do your own due-diligence on the project. You need to know what problem the cryptocurrency is trying to solve and how much need their is for that solution in the real world. You don’t want to invest in a solution that’s trying to find a problem, so make sure that there is actually demand for that solution first.

For Bitcoin, for example, the problem is simple: governments are historically irresponsible with money and inflate the value of their currencies beyond use, harming people who save money because it buys less and less over time. Bitcoin solves this issue by allowing people to store their wealth somewhere that can’t be manipulated by governments and won’t lose value over time.

Another problem exists within Ethereum itself. Programs (dApps) built on the Ethereum blockchain are becoming too expensive for the average person to afford because the transaction (gas) fees are too high. The reason they’re high is because Ethereum has a lot of transactions competing to be processed, and they’re not all processed in order. Instead, each user bids a certain gas fee and whoever pays the highest amount will be processed first. Without a high bid on gas, your transaction could take hours to process, which is extremely inefficient. Imagine buying coffee at Starbucks and having to wait an hour for the payment to clear. Even worse, imagine paying more for the transaction fee than you paid for the coffee.

Right now there are several solutions (opportunities) being proposed in the form of competing/complimentary cryptocurrencies. Cardano, for example, is looking to improve on what Ethereum does right (dApps), while eliminating what it does wrong (low transactions per second and high fees). It’s an entirely separate network that is trying to become a better version of Ethereum, and depending on how long it takes Ethereum to fix it’s issues, it very well may.

Matic Network is a dApp built inside Ethereum which seeks to solve this problem in it’s own unique way, as more of a compliment to the network than a competitor. This is called a “Layer 2” solution because it is native to Ethereum and built “on top” of it.

You can think of your own real life problems as well and try to find cryptocurrency projects that are trying to solve them. Maybe there is a better way to monitor credit than three centralized bureaus? Maybe there is a better way to track your business’s supply chain and keep all parties accountable? Maybe there is a better way for doctors upload the medical records of their patients so they can more easily transfer those records between hospitals and specialists?

Basically, what problems exist that could be solved or improved by cutting out a middle-man (central authority) who either slows down the process, controls all of your data, imposes an unnecessary cost, or poses a security risk?

There are an almost unlimited number of problems that can be solved with blockchain technology, so once you find a good one, the question becomes: what project is solving this problem?

Most serious cryptocurrency projects upload a whitepaper which explains in detail what they’re trying to accomplish and how their cryptocurrency works. Spend some time getting familiar with the project and learning how it operates. Then look at the team who is putting it together. What experience do they have? What are their accomplishments? Are they capable of carrying out what they are trying to do? What obstacles can this project face along the way and how can it overcome them?

All of your answers are going to come from asking these questions. Be critical and be ruthless in your research because if you get the fundamentals wrong, your portfolio will suffer the consequence.

Again, make sure to allocate capital according to the risks. You can always add more capital later once you’re starting to see success in the project.

Buying your cryptocurrency.

Once you’ve identified the projects you’d like to invest in, the next step is to buy them.

Ultimately you want to make sure you’re buying a cryptocurrency for less than what you think it should be worth. The problem is that the prices fluctuate on minute-to-minute basis, and it’s almost impossible to time the “bottom” of a market.

The best approach is to use a method called “Dollar Cost Averaging” (DCA).

If you’re unfamiliar, DCA is when you purchase a fixed dollar amount worth of something over an extended period of time. For example, let’s say you want to buy $1,000 worth of Bitcoin but you’re afraid the price may go lower and you could get a better deal later.

Rather than investing the entire $1,000 that moment, you could buy $250 worth of Bitcoin every Friday for four weeks. Or you could buy $33 worth of Bitcoin every day for a month.

This allows you to buy more Bitcoin on days when the price is lower and “smooth out” the average cost of your investment.

The good news is, most exchanges now allow you to do this automatically right from your account.

When is it time to sell?

Determining when it’s time to sell will come down to your own personal time-horizon. If you’re investing short-term, such as a few months to a year, you’ll want to set a more conservative price target than you would if you’re planning 5 to 10 years out.

Cryptocurrency typically has a 4-year boom and bust cycle, so it also depends where we are in the cycle (right now we are in the boom). During this period, prices and returns are often exaggerated until the point at which the market is so overvalued that the bubble bursts and everyone races to sell their cryptocurrency all at once, driving down prices.

For long-term investors, this is why it’s vital to invest in cryptocurrencies with real fundamental value. If it won’t survive through a 4 year winter you probably shouldn’t buy it.

Short-term, if you’re going to sell at all, you’ll want to sell before the bubble bursts. Otherwise expect to wait another four years for your gains to reach and surpass their previous highs.

As a long-term investor, you could just hold onto your investment from the top of the bull market and carry it over to the next one. I’m sure the people who sold their Bitcoin in 2013 for $1,165 felt like geniuses until it climbed to almost $20,000 four years later.

The benefits to this are that you won’t have to pay short-term capital gains tax and depending on the cryptocurrency you own, you may be able to either stake or lend them to earn interest while you wait. In the crypto-world, interest rates are sometimes double-digits, so it’s more worthwhile than your average CD or savings account.

As for me, I’ll only sell when the fundamentals behind my investment change or when I reach my price targets, whichever comes first.

Ignoring The Tribalism.

As you explore these projects, you’ll come to discover that people have an almost religious attachment to their investments.

In the Bitcoin community, these people are called “Bitcoin-Maximalists”. Basically, they believe Bitcoin is the only true cryptocurrency and all others are irrelevant. They think all dApps will be built on Bitcoin and that it’s “The One Coin to Rule Them All.”

Even without considering Bitcoin’s technological limitations which make functional dApps virtually impossible to run on it, this is a very short-sighted and closed-minded view.

The same sentiment can be felt in the Ethereum community by people who believe it’s impossible for a competitor to take Ethereum’s crown, discounting the fact that Ethereum definitely has many problems it needs to figure out.

If I could give one piece of advice to anyone new to this space, I’d say to be as agnostic and unattached to these projects as you possibly can. Yes, you should certainly root for and support your investments and be passionate about them, but don’t let your emotions blind you. In fact, do the opposite. If you’re invested in something, spend time looking for the flaws. Look at the growth and adoption patterns. Continue asking the tough questions, “(How) can this problem be overcome?”

See if your thesis changes based on the answers you’re finding. If you’re investing in a horse and buggy and you realize someone else has built a car, make a judgement call.

Cryptocurrency is not a “winner-takes-all” game. Network effects and first-mover-advantages are real, but poor technology or implementation will only stay relevant for so long.

Don’t be a maximalist.

Final Considerations.

There are a few technical components to cryptocurrency that I haven’t discussed here at all, such as consensus algorithms and the blockchain itself. Understanding these concepts will be vital to fully understanding what cryptocurrency is, how it works, and why we need it.

I will write more about those concepts in the future, but if you’re entirely new to cryptocurrency, reading articles a few articles about the blockchain is a must. Throughout this article I have deliberately replaced the word “blockchain” with “network” in effort to make this easier to follow for people who are unfamiliar with the terminology.

I wanted to explain cryptocurrency investing as simply as I could, and specifically for people who are getting into this for their first time. I’m sure a smarter person could have kept this more concise, but I hope I’ve been able to assist you on your journey, nonetheless.

Welcome, good luck, and hodl on!