Cryptocurrency

10 things to know before you start investing in cryptocurrency

You want to start investing in cryptocurrencies, but don’t know what exactly it is and where to start? Then read on, as this post will help you to understand the topic in more detail.

Cryptocurrency started with Bitcoin invention in 2008 by Satoshi Nakamoto and its official launch in 2009, when first actual Bitcoin was mined. The main idea behind bitcoin was to provide fully digital money that are independent from any government or commercial institution, and thus can be trustworthy and not manipulated by any interested party. To make it independent from any central authority, Bitcoin was created on a distributed (decentralized) ledger technology, where transaction verification doesn’t require any central authority and is performed by network members instead.

Soon after Bitcoin another cryptocurrency was born – Ethereum. It was developed by Vitalik Buterin to provide a cryptocurrency and platform for smart contracts – contracts that will be enforced automatically by the distributed ledger, as opposed to current bureaucratic and legal systems that we are using. Smart contracts allow counterparties to enter into a specific agreement and make sure that this agreement terms will be respected, as agreement logic and rules are implemented in the decentralized platform.

Once Bitcoin and Ethereum gained some traction, many more cryptocurrencies and crypto assets were introduced. I compiled a list of 10 things that I believe are important to understand before investing in cryptocurrencies.

1. Cryptocurrency is digital money, but it’s not backed by government and lacks protection you have as a bank customer

Be aware that cryptocurrencies are not protected in the same way as your bank deposits are, and legal protection you have for your debit or credit cards doesn’t apply to crypto wallets.

Bitcoin

Since these are fully digital money, it is impossible to get it back if you made a transfer by mistake or if it was stolen by hackers. If you use a crypto wallet you need to do your own research on wallet security and decide how trustworthy it is.

2. You need a digital wallet to use cryptocurrencies

In order to use cryptocurrencies you need a crypto-wallet. Some of these wallets are very basic and not very user-friendly, while some services provide easy to use wallets. Beware that your crypto wallet can be accessed only with a secure key, so if you lose or forget your secure key, you won’t be able to get hold of your cryptocurrency anymore. Pay special attention to your crypto wallet protection.

Crypto wallet

Most popular crypto wallets are:

  • TrustWallet
  • Ledger (hardware wallet)
  • Trezor (hardware wallet)
  • These are affiliate links, please see affiliate disclosure at the bottom of this page

If you want to learn more about different types of wallets, read my post here

You can also buy cryptocurrencies on crypto exchanges, via special websites or using your bank account (mostly with challenger banks and fintechs). You need to understand what functionality and security you will get with different options, for example some banks may allow you to invest in cryptocurrencies, but you won’t be able to make transfers or payments. To avoid disappointment read terms and conditions carefully.

3. Cryptocurrency transactions are not always free

Transaction

There is a wide misconception that cryptocurrency payments are hassle free, quick and have no cost. In reality, different cryptocurrencies offer different timescales for your transfer and you will have to find out what are the costs associated with money transfer and how much time this transfer will take, which is specific to each cryptocurrency.

4. Blockchain is not a cryptocurrency – it is a technology behind crypto currencies.

Many people talk about blockchain in the context of cryptocurrencies, so it’s important to understand that blockchain is not a cryptocurrency.

Blockchain is a technology that allows cryptocurrencies to function without a centralized intermediary. To put it simple, blockchain is a technology that allows cryptocurrencies to function.

Blockchain

Blockchain is also known as a distributed ledger system, which means that information that is stored on this system is validated in a decentralized way, as opposed to centralized systems, where verification and validation of information is performed by a central authority.

Many people don’t like the idea of a centralized intermediary (like payment processor or national central bank) , as it puts too much power in hands of a central authority, and also makes the whole system dependent on this central authority, making it less stable and dependent on central authority actions.

As opposed to centralized intermediary ledger, decentralized ledger allows system to function without dependency on the central function. Please note that if something is built on a blockchain it doesn’t automatically mean that this service is secure and works as expected – as any other software product it has to be tested by user community and checked for security flaws, so do your research before committing to a particular digital asset just because it is built on a blockchain.

5. Cryptocurrencies are very volatile

Volatility of cryptocurrency

Cryptocurrencies can be extremely volatile and you may lose all your invested capital in minutes. Even most liquid coins such as Bitcoin and Ethereum show extreme volatility, but more exotic coins can widely appreciate and then suddenly drop to zero. So, as with any other investment it is important to do your research and diversify as much as possible.

6. There are many digital assets

While Bitcoin , Ethereum , Ripple and Litecoin are hitting the news, there are other interesting digital assets. So what else is there? First of all, there are many crypto coins that are addressing deficiencies of existing cryptocurrencies. For instance, Litecoin has a faster transaction processing speed than Bitcoin, Tether coins (such as USDT) are pegged to a particular currency and crypto tokens have additional properties.

Digital assets

What are these crypto tokens? Crypto tokens are crypto assets that can have more features than crypto currency – e.g. these can represent an interest in a particular project, or have very specific properties that go beyond normal currency use. Usually these tokens get issued via a process called ICO (Initial Coin Offering).

It’s important to keep in mind that crypto tokens may have very complex logic behind them and it’s worth investing time in researching ICO prospectus and other relevant information before making any investment decision.

7. You can buy cryptocurrencies for fiat money or mine them

Cryptocurrencies can be purchased using your crypto wallet, traded on the crypto exchange or mined. There are many wallet providers that offer different types of wallets, you can check out this post on crypto wallets.

Alternatively, you can buy cryptocurrency at one of crypto exchanges. Most established exchanges are Binance, Coinbase and Kraken (these are affiliate links, see details in the Affiliate Disclosure below). You can read more about crypto exchanges here

Bitcoin mining

Another way to acquire cryptocurrency is through a process called mining. Mining is a process of verifying a transaction and adding it to a blockchain. Each cryptocurrency has its own mining protocol which you have to follow. It was extremely profitable to mine cryptocurrencies in the beginning, but now, due to increased complexity and competition doing it individually may not be so lucrative. As a result, individual miners tend to participate in mining pools or use mining services.

8. You can trade cryptocurrencies and its derivatives

Cryptocurrency trading

As cryptocurrencies evolve, more and more financial instruments become available. Now you can trade Bitcoin futures on traditional exchanges and crypto exchanges. If you are more sophisticated investor, you can trade options contracts too, but please check your local regulations before doing it, as some countries banned crypto derivatives and you may be breaking the law by investing in these instruments. There are special crypto exchanges for trading cryptocurrency options – these are Deribit and Quedex.

9. Beware of frauds and scams

Bitcoin

Unlike fiat money and traditional financial instruments, crypto assets are not regulated, are not transparent enough and lack legal protection. As a result there were many projects that raised money and then disappeared, leaving investors with empty pockets. Also, some crypto exchanges were hacked and money was stolen, not to mention people who didn’t protect their crypto wallets properly and lost their money to hackers.

10. Different countries have different laws in relation to cryptocurrencies and regulatory landscape may change

Cryptocurrencies legal considerations

There is no international regulation in relation to cryptocurrency status and regulation – some countries are more advanced than others. If you plan to invest in cryptocurrencies it’s worth seeking advice from investment professionals on legal, regulatory and tax implications in your country. From investment perspective it’s also worth noting that some regulatory developments may be positive for cryptocurrencies (e.g. official recognition by regulators, legal status etc.), while some can be devastating (e.g. full ban).