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Cryptocurrency has become a mainstream investment asset class, but getting started can be challenging. With the unregulated nature of the crypto market, investing in cryptocurrencies can feel like venturing into the Wild West rather than Wall Street. In this article, we will explore the basics of cryptocurrency and provide guidance on how to begin investing in this exciting and dynamic market.
What is Cryptocurrency?
Cryptocurrency is a type of digital currency that operates without the need for a central authority to verify transactions or create new units. Instead, it relies on cryptography to prevent counterfeiting. Blockchain technology, which consists of individual blocks of data linked together, supports cryptocurrencies. Each block contains information about transactions made in a specific cryptocurrency and references the previous block, creating an immutable chain. This cryptographic reference ensures that the data remains secure and cannot be altered by hackers.
Currently, there are thousands of cryptocurrencies in existence, thanks to the ease of creating new currencies using smart contracts. These new coins can leverage existing blockchains with established networks of computers to verify transactions.
How to Pick a Cryptocurrency to Invest In
Before investing in any cryptocurrency, it is crucial to conduct thorough research. Unlike picking stocks, selecting a cryptocurrency requires a different set of considerations. While stocks represent ownership in a company that generates profits, cryptocurrencies lack intrinsic value. The price of a cryptocurrency is determined by supply and demand dynamics. Increased demand and limited supply can drive up prices, while constrained supply or decreased demand can lead to price declines.
When evaluating a cryptocurrency, it is essential to answer two key questions: How does the supply increase, and what factors will drive demand higher? To answer these questions, read the white paper published by the cryptocurrency team to understand their project’s goals. Examine their roadmap for any forthcoming developments that could stimulate demand. Research the team behind the project to assess their skills and ability to execute their vision. Lastly, engage with the cryptocurrency community to gauge overall sentiment and gain insight from experienced investors.
Additionally, consider the amount of money already invested in a particular cryptocurrency. If the market cap is already high, there may be limited potential for further growth. A high price can curb demand and prompt early investors to sell their holdings.
How to Invest in Cryptocurrencies
Once you have identified a cryptocurrency to invest in, the next step is to open an account with a cryptocurrency exchange. It’s important to note that most traditional stock brokers do not support cryptocurrency trading. Popular and beginner-friendly exchanges in the U.S. include Coinbase, Gemini, Robinhood, and SoFi. Ensure that the exchange you choose supports the specific cryptocurrency you wish to purchase.
After funding your account with fiat currency, you can place an order to buy the desired cryptocurrency. Exchanges work similarly to stock markets, matching your buy order with someone selling at the same price. Once the trade is executed, the exchange will hold your cryptocurrency in a custodial wallet.
It’s important to remember that investing in cryptocurrencies comes with volatility. Crypto assets are generally more volatile than traditional asset classes like stocks, with price swings of 10% or more in just a few hours being common. To manage this volatility, establish wide bands of acceptable allocations for your cryptocurrency investments. Regularly rebalance your portfolio if your investments fall outside of these bands.
Advantages and Drawbacks of Cryptocurrency Investment
Investing in cryptocurrencies offers several advantages:
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Diversification: Cryptocurrency values do not appear to be correlated with traditional assets like stocks and bonds, providing diversification benefits to investors.
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Return Potential: Cryptocurrencies have shown strong returns as adoption has increased. Many investors believe that the expected return for a sound cryptocurrency investment is higher than that of stocks.
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Additional Utility: Some cryptocurrencies, like Bitcoin, provide utility as a medium of exchange. Other cryptocurrencies, such as Ethereum, power decentralized finance (DeFi) applications and smart contracts.
However, there are also drawbacks to consider:
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Limited Regulation: The cryptocurrency industry is currently under-regulated, meaning investors do not have the same protections as in heavily regulated stock markets. Hacking incidents or scams can result in the loss of investments without recourse. Additionally, increased regulation may negatively impact the demand for certain cryptocurrencies.
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High Volatility: Cryptocurrency prices can experience significant and rapid fluctuations, which may be challenging for some investors to handle.
Top Cryptocurrencies for Beginner Investors
For beginner investors, it is advisable to start with established cryptocurrencies that have built-out networks. This approach allows investors to familiarize themselves with the mechanics of cryptocurrency investing and understand how it fits into their overall portfolio.
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Bitcoin (BTC): As the most well-known cryptocurrency, Bitcoin is an excellent starting point for beginners. It is widely adopted and serves as a digital cash system, providing a first-mover advantage in the market.
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Ether (ETH): Ethereum’s technology supports many decentralized finance (DeFi) projects, which use the Ethereum blockchain for smart contracts and financial services. Increased adoption of DeFi applications will likely drive demand for Ether.
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Cardano (ADA): Cardano offers an alternative to Ethereum, focusing on energy efficiency through a proof-of-stake system. It has lower transaction fees compared to Ethereum and a hard cap on token supply, potentially driving future price increases.
In conclusion, investing in cryptocurrencies requires diligent research and the ability to tolerate volatility. By selecting established cryptocurrencies, conducting thorough evaluations, and managing risk, investors can navigate the exciting world of cryptocurrency and potentially achieve strong returns.
Source: Pentawallet
