Cryptocurrencies have outperformed just about every other asset class this year, causing a lot of investors to wonder whether they should include Bitcoin, Ethereum or other coins in their portfolios.
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While there are differing opinions about Bitcoin and other cryptocurrencies, this asset has catapulted in popularity and is gaining widespread demand from individual and institutional investors alike.
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Bitcoin is trading at all-time highs, eclipsing $68,000 on Nov. 10, and the bullish sentiment is far from easing. The second-biggest cryptocurrency, Ethereum, is also at record levels. As the two largest cryptocurrencies keep hitting the ceiling, the market capitalization of the crypto market keeps climbing, now surpassing $3 trillion.
If one thing is for sure, cryptocurrency is not going away. As more businesses accept cryptocurrency and the blockchain technology that facilitates its operation, you may inevitably have to learn the dynamics of the crypto world and even consider investing in it.
Here's what you need to know about this asset class:
What is cryptocurrency?
How to invest in cryptocurrency.
What to consider before investing in cryptocurrency.
How to make money with cryptocurrency.
What Is Cryptocurrency?
Cryptocurrency is any digital currency secured by cryptography, or secure communications, that is used as a medium of exchange that allows peer-to-peer transactions.
Bitcoin, the first blockchain cryptocurrency, is a form of digital currency invented in 2009 by an anonymous founder using the pseudonym Satoshi Nakamoto. Cryptos aren't managed by a bank or public agency. Instead, transactions of cryptocurrency tokens are typically recorded on a public blockchain – comprising digital information stored on a database.
Blockchain technology is used to keep an online ledger of all the transactions, and it provides a data structure for the ledger that is considered secure.
Unlike fiat money – that is, government-issued currency – which is controlled by central banks, cryptocurrencies do not require banks to verify transactions and are independent of a central banking authority.
There are thousands of cryptocurrencies, each with its own security standards and value propositions, but Bitcoin is the most well known. At the time of this writing, its value is up more than 130% in 2021. Other popular cryptocurrencies include Ethereum, Litecoin and Cardano.
While cryptocurrency is a newer phenomenon, it has the potential to revolutionize the financial system and how we think about money.
"Cryptocurrency is a new asset class that is at the foundation of the cryptoeconomy – an entirely new set of financial services, commerce and global payments that will be built on top of this new technology," says Max Branzburg, vice president of product at Coinbase Global Inc. (ticker: COIN), one of the leading crypto exchanges.
James Putra, senior director of product strategy at TradeStation Crypto, says cryptocurrencies are opening retail investors to "a world of global capital, as opposed to what they can access through the U.S. market."
How to Invest in Cryptocurrency
There are many cryptocurrencies on the market that have different fundamental values. Investors should recognize that a cryptocurrency can be here one day and gone the next, which could leave your investment worthless. That's why it's important to have a strategy around investing in cryptocurrencies and know how to manage your risk.
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Cryptocurrency trading beginners may want to consider things like transaction fees, the type of cryptocurrencies available on the platform, special offerings like resources for education and other features that align with your interests and goals.
There are many cryptocurrency exchanges from which to choose. TradeStation, Coinbase, eToro and Gemini, among others, offer an easy, accessible and secure platform to own and transact Bitcoin.
When investing in cryptocurrency, consider the role it will play in your portfolio.
Experts say it's best to take a balanced approach toward investing in cryptocurrencies. Putra says a small portion, between about 2% and 5%, can safely be allocated to crypto in your investment portfolio because the volatility of this asset can cause its value to change dramatically.
For investors who want to use cryptocurrency as a way to diversify their portfolio, Putra says, cryptocurrencies are one of the least correlated assets to stocks and bonds, meaning they can be an effective hedge against those other asset classes.
Investors may also choose cryptocurrency as an inflation hedge. Putra says that since bond yields are not keeping up with inflation, you can turn to some cryptocurrencies as a bond alternative.
"Because of the low interest rates across bonds, there is a reshuffling of capital on a macro level out of bonds and into other assets that are more inflation-protected," Putra explains.
Some cryptocurrencies like Bitcoin or Ethereum can provide some stability to your portfolio, he says. "Even though they have some volatility, they are inflation-protected."
What to Consider Before Investing in Cryptocurrency
Investing in cryptocurrencies is very speculative.
Despite stories of investors making millions, investing at an inopportune time can result in rapid and extreme losses.
Although the chance of striking it rich by investing in cryptos is enticing, it's important to understand the characteristics of cryptocurrency. First and foremost, this market is extremely volatile. An asset that can rise so quickly is also prone to equally severe drops.
Another risk: Unlike in other markets, the future of cryptocurrency regulation is uncertain. Some countries that allow the more or less free use of Bitcoin include the U.S., Canada and Australia, to name a few. El Salvador even adopted Bitcoin as a legal tender. But other countries, like South Korea, are pushing restrictive regulation on cryptocurrency, while China has essentially banned cryptocurrency. Even in the U.S., new legislation targets crypto investments for taxation.
Cryptocurrencies are conceived of as a unit of exchange, but today, there are only a handful of businesses that accept crypto as a form of payment. Crypto advocates support its utility for broad economic use, but this adoption could take time since regulators around the world are critical of the digital asset.
Calculating the intrinsic value of cryptocurrency may be more difficult than for a publicly traded company, but learning about the asset and how it performs might help prevent you from investing at a peak.
By incorporating industry knowledge and developing an understanding of the digital currency market, you will become a more educated cryptocurrency investor.
How to Make Money With Cryptocurrency
There are several ways investors can increase the value of their assets and secure a profit when investing in cryptocurrency.
"You can get more out of your money with cryptocurrency than with other traditional assets," Branzburg says.
The first method he points to is staking. Staking lets you earn income with your crypto by participating in the network of the asset. When you stake your crypto, you make the underlying blockchain of that asset more secure and more efficient. And in exchange, you get rewarded with more assets from the network, like a yield you would get from a savings account.
Some cryptocurrencies that offer staking rewards include Cardano, Ethereum 2.0, Tezos and Algorand.
Another opportunity Branzburg mentions is lending your crypto assets for yield.
"You can lend the assets that you have in your portfolio into decentralized finance, or DeFi, protocols to generate yield, as well," Branzburg explains.
Lending through DeFi, Branzburg says, allows users to "tap into a global liquidity pool." By lending your crypto assets into a decentralized money market, other users have access to borrowing your assets, allowing you to generate yield.
Takeaway
Cryptocurrency is a new and exciting way to think about money. But experts say the first and most important step is to educate yourself on these emerging digital currencies and the technologies they use so that you can understand the risks and rewards.
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