Thestreet's Guide To Investing In Bitcoin

Investing in Bitcoin can be a risky business, so it's important to understand the process and the market before you begin. Bitcoin is a cryptocurrency, a digital asset that uses cryptographic computer networking technology called blockchain, which enables people to exchange money without the need for a central authority like a bank.

There are several ways to buy Bitcoin, including through cryptocurrency exchanges, traditional stockbrokers, money transfer apps, Bitcoin ATMs, and Bitcoin exchange-traded funds (ETFs).

Once you've purchased Bitcoin, you'll need to store it in a digital wallet. There are two types of wallets: hot wallets, which are connected to the internet, and cold wallets, which are not. Hot wallets are faster for transactions, but cold wallets are considered more secure.

It's also important to consider your risk tolerance and investment strategy before investing in Bitcoin. While it can be tempting to try and make a quick profit, it's crucial to remember that the market is highly volatile, and you could lose money as well as make it.

Bitcoin wallets

There are two main types of wallets: custodial and non-custodial. Custodial wallets (also called online wallets) are hosted by a third party that stores your keys for you. This could be a company that provides enterprise-level data security systems that businesses use to preserve and secure data. Some cryptocurrency exchanges offer custodial wallets to their customers. Non-custodial wallets are wallets in which you take responsibility for securing your keys. This is the type that most cryptocurrency wallets on devices are.

There are two subcategories of wallets: hot and cold. A hot wallet has a connection to the internet or to a device with a connection, and a cold wallet has no connection. Lastly, there are three subcategories of wallets—software, hardware, and paper. Each of these types is considered either a hot or cold wallet.

• Software wallets: Applications for desktops and mobile devices. These wallets are installed on a desktop or laptop computer and can access your cryptocurrency, make transactions, display your balance, and more. Some software wallets also include additional functionality, such as exchange integration if you're using a wallet designed by a cryptocurrency exchange.
• Hardware wallets: The most popular type of wallet because you can store your private keys and remove them from your device. These devices might resemble a USB drive, and modern hardware wallets have several features. You can make a cryptocurrency transaction on your computer or device by plugging in the hardware wallet. Most of them can sign cryptocurrency transactions automatically without requiring you to enter the key, circumventing a hacker's ability to log your keypresses or record your screen.
• Paper wallets: Early crypto users would write or type their keys on paper, which they called paper wallets. These evolved to include the keys and QR codes so that wallets on mobile devices could scan them. However, paper wallets are easily damaged or lost, so many crypto owners do not use them anymore.

Cryptocurrency exchanges

A cryptocurrency exchange is a business that allows customers to trade cryptocurrencies or digital currencies for other assets, such as conventional fiat money or other digital currencies. Exchanges may accept credit card payments, wire transfers, or other forms of payment in exchange for digital currencies or cryptocurrencies.

A cryptocurrency exchange can be a market maker that typically takes the bid-ask spreads as a transaction commission for its service or, as a matching platform, simply charges fees. Some brokerages that also focus on other assets such as stocks, like Robinhood and eToro, let users purchase but not withdraw cryptocurrencies to cryptocurrency wallets. Dedicated cryptocurrency exchanges such as Binance and Coinbase do allow cryptocurrency withdrawals, however.

A cryptocurrency exchange can typically send cryptocurrency to a user's personal cryptocurrency wallet. Some can convert digital currency balances into anonymous prepaid cards, which can be used to withdraw funds from ATMs worldwide, while other digital currencies are backed by real-world commodities such as gold.

The creators of digital currencies are typically independent of the digital currency exchange that facilitates trading in the currency. In one type of system, digital currency providers (DCP) are businesses that keep and administer accounts for their customers but generally do not issue digital currency to those customers directly. Customers buy or sell digital currency from digital currency exchanges, who transfer the digital currency into or out of the customer's DCP account. Some exchanges are subsidiaries of DCPs, but many are legally independent businesses. The denomination of funds kept in DCP accounts may be of a real or fictitious currency.

A digital currency exchange can be a brick-and-mortar business or a strictly online business. As a physical business, it exchanges traditional payment methods and digital currencies. As an online business, it exchanges electronically transferred money and digital currencies.

Often, the digital currency exchanges operate outside Western countries to avoid regulation and prosecution. However, they do handle Western fiat currencies and maintain bank accounts in several countries to facilitate deposits in various national currencies.

Decentralized exchanges such as Etherdelta, IDEX, and HADAX do not store users' funds on the exchange but instead facilitate peer-to-peer cryptocurrency trading. Decentralized exchanges are resistant to the security problems that affect other exchanges, but as of mid-2018, they suffer from low trading volumes.

When choosing a cryptocurrency exchange, it is important to do your research and find out about accounts, key storage, wallets, security, user satisfaction, and features. Fees can add up, so make sure you understand how each exchange and blockchain charge you for transactions.

It is also important to use a reputable and regulated cryptocurrency exchange for your own safety. Mt. Gox, one of the earliest digital currency exchanges and once one of the most popular, collapsed after a hack. Others have also been hacked or otherwise compromised.

How to Choose a Cryptocurrency Exchange

• Security: The harder it is to create an account at a particular exchange, the better. If it's too easy to generate an account, this suggests that an exchange is not particularly trustworthy. Regardless of the exchange you choose, consider keeping most of your digital assets in an offline storage service like a cold wallet.
• Fees and Currency Pairs: Most crypto exchanges will include some type of fee for your transactions, which can be based on the transaction size or your activity level. Learn about the fees and consider how they would impact your investing strategy. Another important consideration is the cryptocurrency pairs that an exchange offers. For example, Coinbase, one of the world's most popular and successful exchanges, offers more than 9,600 assets on its exchange, but only about 420 are available in tradeable pairs.
• Legitimacy: To ensure the legitimacy of a cryptocurrency exchange, look for the physical address associated with the exchange. If there is no address readily available, you should not use it. Transparency is often a sign of legitimacy, and knowing the exchange's location will help you understand the legal ramifications of your investments.

Traditional stockbrokers

It is important to note that not every online platform or application allows investors to own standalone Bitcoin. For example, while Coinbase allows investors to buy Bitcoin and store it in their own encrypted wallets, Robinhood does not. Instead, Robinhood investors can only take advantage of the price movements in their accounts and cannot transfer holdings to an encrypted wallet.

Bitcoin ATMs

There are tens of thousands of Bitcoin ATMs worldwide, with most of them located in the United States. As of September 2021, there were more than 24,700 bitcoin ATMs in the US, up from 2,342 in January 2018. Bitcoin ATM providers are companies that manufacture, deploy, and sometimes operate Bitcoin ATMs. They are responsible for the hardware and software that powers the machines, ensuring that they are secure, user-friendly, and compliant with local regulations.

Some Bitcoin ATMs require users to have an existing account to transact, and most US cryptocurrency ATMs charge transaction fees between 6.5% and 20%.

Bitcoin exchange-traded funds

Bitcoin ETFs work by using futures contracts to track the price movements of Bitcoin. Fund managers purchase these contracts and bundle them into a fund, which is then sold to investors as shares. These shares are traded on mainstream exchanges, providing investors with exposure to Bitcoin's price volatility without the need to own or store the cryptocurrency directly.

The first Bitcoin-linked ETF was the ProShares Bitcoin Strategy ETF (BITO), approved by the SEC in October 2021. This ETF primarily uses futures contracts to track Bitcoin's price. Other similar ETFs include the Valkyrie Bitcoin and Ether Strategy ETF (BTF) and the VanEck Bitcoin Strategy ETF (XBTF).

There are several advantages to investing in Bitcoin ETFs. They provide exposure to Bitcoin without the need for security procedures, excessive funds, or the hassle of buying and storing the cryptocurrency directly. ETFs are also more familiar investment types for many investors and are traded on regulated exchanges. Additionally, the high price of Bitcoin may be a barrier for retail investors, but ETFs allow them to gain exposure to Bitcoin within their budget and risk tolerance.

However, there are also some disadvantages and limitations to consider. Bitcoin ETFs may have higher fees and expenses than other ETFs, and they are subject to the volatility of the crypto markets. Additionally, there is a risk of tracking error, where the ETF's performance may not directly match the exact current value of Bitcoin due to management fees, transaction costs, or logistical issues. Regulatory uncertainty in the cryptocurrency industry can also impact the legality, trading, and valuation of Bitcoin futures ETFs.

Overall, Bitcoin ETFs provide a way for investors to gain exposure to Bitcoin and other cryptocurrencies without the need for direct ownership. However, it is important to carefully consider the risks and expenses associated with these investments before making any decisions.

Frequently asked questions