Over the past year, it’s been hard to scroll through business news without reading think-pieces about cryptocurrency, how to invest in it, and whether you’d be a fool to do so.
This elevated interest, prompted by the potential approval of the United States’ first spot crypto exchange-traded fund, is but the latest in a long string of bear and bull markets that have characterized the crypto space over the past 15 years.
Over that timeframe, cryptocurrencies have grown from a novelty, best encapsulated by the 2010 sale of two pizzas for 10,000 Bitcoins, to an asset class vying to become the next major industrial sector, with a US$1.62 trillion market capitalization as of Dec. 12.
With global crypto investors growing by more than 100x since 2016 to more than 500 million, and showing no signs of letting up, newcomers should know the basics before allocating their first dollar.
What are cryptocurrencies?
To make sure we’re all clear on terminology, we can define a cryptocurrency as an encrypted currency to pay for products and services on a specific online network. These networks, known as blockchains, are decentralized, meaning they’re operated by the users themselves, offering the benefits of equal access, greater efficiency and lower fees compared with relying on a service-providing middleman.
Tens of thousands of cryptocurrencies and blockchains are in existence today looking to streamline legacy processes across the global industrial complex, with considerable development in finance, gaming, smart contracts, software development and record-keeping. The most well-known cryptocurrencies are Bitcoin and Ethereum.
Bitcoin was designed to function as a source of value outside of government control, and has amassed a market capitalization of US$805 billion as of Dec. 12. The currency’s widespread adoption – including becoming legal tender in El Salvador, offering flared gas a second life, and potentially lowering remittance fees – has grown to about 210 million investors, according to Henley & Partners’ Crypto Wealth Report.
Ethereum, for its part, is a technology platform that facilitates digital payments and application development. The platform’s cryptocurrency, known as Ether, has a market capitalization of US$261 billion as of Dec. 12, and stands second only to Bitcoin, thanks to hosting some of the most important cryptocurrency projects industry wide among its more than 3,000 available applications.
The risks and benefits of investing in cryptocurrencies
Like any asset class, cryptocurrency must earn its place in your portfolio by aligning with your financial goals, time horizon and ability to take risks. Try to have your personal financial profile in mind as you consider the risks and benefits of a crypto allocation.
Risks
Cryptocurrencies are risky investments, first and foremost, because they are an unproven asset class, with Satoshi Nakamoto creating Bitcoin only in 2008, prompted by hundreds of billions in U.S. bank bailouts because of the Great Financial Crisis, regardless of the banks seeming to be responsible for all the trouble.
Fifteen years of history is not long enough to determine an asset class’s return characteristics, as evidenced by the S&P 500 rising only 8.8 per cent from Feb. 9, 1966, to Aug. 12, 1982, even though it has rewarded shareholders with a more than 2,500 per cent return since then.
Cryptocurrencies’ short history makes investing in them a matter of speculation, where your own research must justify their place in your portfolio, despite their considerable volatility and lack of evidence supporting a positive expected return.
It’s this short history that is partially behind the lack of regulatory clarity about how the crypto industry should move forward. Ongoing work at the U.S. Securities and Exchange Commission about whether cryptocurrencies should be regulated as securities may determine their ultimate fate, given that the U.S. is the largest economy by GDP and makes up more than half of global stock market capitalization. China, the world’s second-largest economy, enforced a crackdown on crypto operators in 2021.
U.S. financial regulators’ inability to offer clear and concise crypto policies, unlike Canada, likely stems from confusion over the fact cryptocurrency projects, by and large, are not run for profit, but for the benefit and strength of their hosted app ecosystems. This means that, while a given ecosystem might contain numerous for-profit apps, and compensate certain parties for facilitating transactions, fees collected for participating in the ecosystem are reinvested, not returned to shareholders, making cryptocurrency valuation an esoteric challenge for retail and institutional investors alike.
Benefits
The benefits of investing in cryptocurrency centre on the asset class’ ability to generate returns commensurate with its sky-high risk.
If you bought Bitcoin in December 2015 at around US$400 per coin, you’d be sitting on a more than 100x gain as of Dec. 12, compared to a 0.5x increase for the TSX over the period. Not to be outdone, Ether has grown by about 18,000 per cent since inception in 2016, with one coin commanding US$2,176 as of Dec. 12.
These life-changing returns are a common occurrence in the crypto space, but your ability to buy into a project at the right time relies heavily on your due diligence and comfort pitting your hard-earned dollars against the risks discussed above.
Additional investor benefits have to do with cryptocurrencies’ role as a gateway to decentralized applications and Web 3.0. Specific examples of next-gen services you can use crypto to participate in include play-to-earn games, such as Axie Infinity; access to the metaverse, such as through Decentraland; decentralized lending, such as through Aave; and staking, which involves locking up your crypto to enable the secure processing of transactions in exchange for a return.
How to invest in cryptocurrency: a step-by-step guide
Now that we’ve considered the pros and cons of allocating into crypto, we can address the specific steps required to open positions in them.
1. Performing due diligence on your potential crypto holdings
Before you invest in any kind of financial instrument, it’s essential to carefully consider its prospects for success and size your position such that it lets you sleep soundly at night. Most financial professionals recommend no more than a 5 per cent allocation to crypto, contingent on your conviction in the asset class.
Key project attributes to look out for include user growth, the track record of its original developers, and whether the associated blockchain network brings innovation to its area of focus.
The Solana network, for example, is able to process up to 2,000 transactions per second at very low costs, which has led to a partnership with Visa to enhance its stablecoin settlement pilot. Stablecoins – cryptocurrencies that track fiat currencies, such as the Canadian or U.S. dollar – have become one of the main drivers of arguments supporting crypto’s longevity.
Resources such as Coin Market Cap, CoinDesk and The Market Herald Canada’s crypto coverage are great places to start your research process and familiarize yourself with what the industry has to offer.
2. Choosing a crypto exchange or digital wallet
Investors have two primary options when it comes to choosing who to trust with protecting their cryptocurrency.
They can create an account with a crypto trading platform approved by the Canadian Securities Administrators, including Wealthsimple, Fidelity, Netcoins, Coinsquare and BitBuy. Investors should expect to provide detailed financial information about themselves, including Social Insurance number if they’re opening a registered investment account, like a TFSA or RRSP.
Whether you’re interested in bare-bones discount brokerages or a heftier feature set for advanced trading, an option is out there for you, supposing you’re comfortable with the risks of holding decentralized assets in a centralized location, such as data breaches and insufficient insurance coverage – given that crypto is not covered under the Canadian Investor Protection Fund – in the event of one.
Investors less trustworthy of third-party custody can purchase a cold wallet, or a physical hardware device on which to store their digital assets. These devices can be connected to a computer through a USB cable and are secured by two sets of characters, a public key and a private key, the first of which allows you to access your holdings, while the latter allows you to send and receive assets. Hot wallets, online versions of their cold counterparts, are also widely available, but are more risky because of their lack of regulation and vulnerability to hacks.
Key points to consider when shopping for a crypto custody solution are:
- Level of security, as demonstrated by advanced cryptography and the ability to continually update against the latest threats
- Level, if any, of investment and deposit protection, including coverage from the Canada Deposit Insurance Corporation
- Ease of use, as demonstrated by clear explanations and an uncluttered user interface, making it unlikely for a customer to enter an incorrect blockchain transaction, which, unlike traditional banking, is irreversible
3. Placing a crypto order
Once you decide on the crypto projects you’d like to invest in, visit your provider of choice and click over to the order portion of the app or website. Then choose the first cryptocurrency you’d like to buy and enter either a desired dollar amount or number of coins. There are two primary order types that investors should know about:
- Market orders are executed at the best available price, meaning they guarantee trade execution, but may come in far above or below that instant’s quoted price
- Limit orders require you to specify the price at which you’d like to buy your crypto, protecting you from the risk of excessive volatility
4. Managing your crypto portfolio
The most important skill in your crypto investing journey concerns portfolio management. This calls for you to decide what percentage each coin will occupy in your portfolio, how long you plan to hold them, and when you’ll rebalance them, while making sure to follow the Canada Revenue Agency’s tax guidelines and keep your overall allocation in line with your financial goals.
Stocks’ proven history of offering about a 5 per cent annual return going back more than 120 years is why they, and not cryptocurrencies, remain investors’ preferred financial instrument for long-term wealth creation.
Additional resources
If you’d like to learn more about how to invest in cryptocurrency, check out Stockhouse’s top five projects to buy in 2023 and our recent survey of the ongoing crypto bull run.
Join the discussion: Find out what everybody’s saying about cryptocurrencies on Stockhouse’s stock forums and message boards.
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