How To Invest In CryptocurrencyUpdated: August 9, 2021
Over the past few years, cryptocurrency has exploded in popularity. In the military community, people now regularly ask about related investing strategies. As a result, we’ll use this article to explain several different options for how to invest in cryptocurrency.
Specifically, we’ll discuss the following:
- What is Cryptocurrency?
- Directly Investing in Cryptocurrency
- Indirectly Investing with Cryptocurrency Stocks
- Earn Interest Lending Cryptocurrency Stablecoins
- Final Thoughts
What is Cryptocurrency?
According to the IRS, a cryptocurrency: […] Is a type of virtual currency that utilizes cryptography to validate and secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. But, unlike traditional currencies like the US dollar, no central government or financial authority controls cryptocurrencies. Rather, mathematics and the decentralized control enabled by this distributed, publicly-available ledger “regulate” cryptocurrencies. Basically, because anyone can see this virtual ledger, people are incentivized to follow the rules.
As a virtual currency, cryptocurrencies also function as a medium of exchange. That is, using this blockchain technology, two people can exchange cryptocurrency to settle a transaction (e.g. one person transfers an agreed upon amount of cryptocurrency to another to purchase an automobile). For instance, Bitcoin, one of the most popular cryptocurrencies, provides both public and private signatures to all users. That way, in a transaction, the sender and receiver must sign off on the exchange with both of these signatures, which are automatically verified for accuracy.
However, unlike the US dollar or other fiat currencies, the value of most cryptocurrencies is not supported by the good faith of a government. Rather, crypto value fluctuates based on the whims of the market and the associated supply and demand factors. This means that, in the right situations, the value of cryptocurrencies can skyrocket. But, the opposite remains true – market factors can lead to massive collapses in cryptocurrency value.
Due to this volatile nature, many people now view cryptocurrency primarily as an investment – not a medium of exchange. If you think the value of your crypto holdings could increase from $20 to $2,000, why would you risk buying a pizza with your cryptocurrency today? In other words, people now see investing in cryptocurrencies as a way to make a significant amount of money – not buy things.
Directly Investing in Cryptocurrency
Before buying cryptocurrencies, people should first understand that “investing” is a bit of a misnomer. Normally, when you buy a cryptocurrency, you don’t receive dividends, interest, or rents like you would with other investments. Instead, you bet that you can sell your holdings for more than you bought them. As a result, purchasing cryptocurrencies is more speculation than investing.
Having said that, you may potentially make a lot of money on a smart crypto purchase. If willing to accept the risks for these potential returns, the question becomes, how do I actually invest in cryptocurrencies?
To purchase crypto, most people use cryptocurrency exchanges. With these exchanges, users register an account and are then able to:
- Buy cryptocurrencies with fiat currencies (e.g. US dollars, Euros, etc.)
- Buy and sell cryptocurrencies using other cryptocurrencies
As with traditional currencies, users will see real-time prices on these exchanges. For example, if a given cryptocurrency is trading at $15, you can purchase 100 units of that particular currency for $1,500 ($15 x 100).
Hundreds of cryptocurrency exchanges exist, but some of the most popular ones include:
Additionally, these exchanges host what’s known as a crypto wallet, a tool for holding all the cryptocurrency you hold. With an online exchange, the incorporated cryptocurrency is a web-based one. This gives you the advantage of being able to access your holdings from any internet-connected device. But, an online wallet also creates the associated risk that someone can hack into that wallet.
Exchanges vs. Wallets
You can also purchase cryptocurrency directly from other people, that is, not on an exchange. But, to do this, you’ll need a crypto wallet. While most exchanges included embedded wallets, a wallet and exchange are actually two different things. An exchange lets you purchase cryptocurrency on the open market, whereas a crypto wallet stores all of your cryptocurrency holdings.
With a wallet embedded on an exchange, you inherently sacrifice some privacy, as you do not have complete control over that wallet. Alternatively, you can use a dedicated crypto wallet. Most of these are held offline, which A) grants you full control, and B) minimizes the likelihood of someone hacking into it to steal your crypto holdings via an exchange vulnerability.
Cryptocurrency Investing Steps
Having outlined the uses – and differences – of a cryptocurrency exchange and wallet, here are the standard steps to investing:
- Step 1: Register with a cryptocurrency exchange.
- Step 2: Connect your bank account to the exchange.
- Step 3: Submit a purchase order for cryptocurrency.
- Step 4 (optional): Transfer your purchases into a dedicated cryptocurrency wallet.
Once you complete Step 3, you have effectively traded your US dollars for cryptocurrency. When you decide to sell some of these holdings, you simply reverse the steps. Instead of creating a purchase order on an exchange, you create a sell order, selling your holdings for the current market rate.
Indirectly Investing with Cryptocurrency Stocks
If you want to invest in real estate, you don’t need to actually buy an investment property. You can buy shares in real estate investment trusts (REITs), construction companies, and other organizations related to real estate. Similarly, you don’t need to directly purchase cryptocurrency to invest in this asset.
A variety of cryptocurrency stocks and mutual funds exist. And, these function like normal, publicly-traded securities, allowing you to buy and sell them on a public market. But, rather than purchasing the underlying cryptocurrency, you purchase shares in an entity that holds or deals with cryptocurrency. This system allows you to gain cryptocurrency exposure in your investment portfolio without directly purchasing coins.
While not an exhaustive list, here are some of the stocks and mutual funds that let you indirectly invest in cryptocurrency:
- Riot Blockchain (RIOT): Riot is a Bitcoin mining company focused on expanding large-scale mining operations in the United States.
- Marathon Digital Holdings (MARA): Marathon is a patent holding company that purchased Bitcoin and Bitcoin mining equipment to expand into cryptocurrency investments.
- Hive Blockchain (HIVE): Hive was the first publicly-traded cryptocurrency miner.
- Voyager Digital (VYGVF): Voyager is a cryptocurrency trading app. While you can use the app itself to purchase crypto, you can also buy shares in the company to gain exposure.
- Bitcoin Strategy ProFund (BTCFX): This fund invests in Bitcoin futures contracts. It is the first publicly-traded fund in the United States that attempts to have results that track Bitcoin’s performance.
NOTE: We are not endorsing any of the above securities. Rather, we are providing them solely as examples. As with all investments, conduct thorough research before purchasing any crypto-related stocks or mutual funds.
Earn Interest Lending Cryptocurrency Stablecoins
As discussed above, most cryptocurrencies have an inherent drawback: volatility. That is, they can experience huge swings in value – often quite quickly.
To combat this volatility, cryptocurrency developers created the stablecoin as an alternative type of cryptocurrency. Rather than fluctuate solely based on market conditions (i.e. supply and demand), stablecoins are pegged to other assets. Normally, these stablecoins track fiat currency like the US dollar or Euro. That is, stablecoins track the performance of these underlying currencies, which provides far more stability and predictability than traditional cryptocurrencies like Bitcoin.
Popular stablecoins pegged to fiat currencies include:
- Tether: An unregulated cryptocurrency pegged to the US dollar.
- Paxos Standard: A cryptocurrency pegged to the US dollar with an official charter from the New York State Department of Financial Services, meaning it can offer regulated services.
- Gemini Dollar: A stablecoin backed by Gemini cryptocurrency but pegged to the US dollar and regulated on a monthly basis.
Due to their stability, stablecoins can be used in lending. Assume you have $100,000 in US dollars. If you lend that money to a borrower, you can collect interest on the outstanding loan. Similarly, investors can now lend stablecoins – not just dollars – to earn interest.
For example, companies like Gemini lend their stablecoins to institutional investors, charging interest in the process. But, Gemini also needs people to first buy its stablecoins before it can actually lend them. Accordingly, investors can A) purchase stablecoins, and B) collect interest on the loans that Gemini makes with those coins.
Currently, this form of lending leads to far higher returns than a traditional savings account, making this a compelling option for investors seeking more stable, higher-yield returns. But, not all stablecoin lending platforms comply to the same lending standards. Prior to pursuing this option, investors should thoroughly research the platform.
Risks to Investing in Cryptocurrency
Before investing in cryptocurrencies, you should consider the below risks.
Cryptocurrencies represent one of the most volatile asset classes currently available. While stocks regularly go up and down, they rarely face the same level of astronomical growth immediately followed by massive crashes that come with cryptocurrency investments. Bottom line, be prepared for massive value swings – for better or worse – with your crypto holdings.
Lack of Regulation
Unlike government currencies and publicly-traded stocks and bonds, cryptocurrencies are not regulated. To some, this serves as a tremendous advantage (e.g. criminals who want to avoid government scrutiny and money trails). But, this lack of oversight also presents tremendous risk, as you largely have no legal recourse if anything happens to your crypto holdings (e.g. you lose them when your cryptocurrency exchange is hacked, which has occurred multiple times).
As illustrated, a variety of options exist to invest in cryptocurrency. You can directly purchase coins, invest in related securities (e.g. stocks and mutual funds), or purchase, lend and earn interest with stablecoins. However, before pursuing any of these options, investors should closely examine the associated risks.
Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.