Cryptocurrency Investment: A Beginner's Guide To Getting Started

Investing in cryptocurrency is a risky business, but it can also be rewarding. If you're thinking about investing in this volatile market, it's important to do your research. Understand the differences between hot and cold wallets, read the white papers, and perform test transactions. Learn about blockchain technology and the thousands of different coins and tokens available. Be aware of the fees and spreads charged by crypto exchanges and brokers, and only invest what you can afford to lose.

Understand the basics of blockchain technology

Blockchain technology is a digital ledger system that forms the backbone of cryptocurrencies. It is a distributed database of records of all transactions or digital events that have been executed and shared among participating parties. Each transaction is verified by the majority of participants in the system.

Blockchain was invented to address the shortcomings of the traditional banking system. For example, when transferring money to overseas markets, a payment could be delayed for days while a bank verifies it. Blockchain technology removes the need for a middleman, allowing for faster and cheaper transactions.

The key features of blockchain technology include:

• Decentralization: Blockchain is a distributed ledger, meaning there is no central hub where transaction data is stored. Instead, data is stored on servers and hard drives worldwide, ensuring no single party can gain control over the blockchain or cryptocurrency.
• Security: Blockchain uses cryptographic functions and digital signatures to protect transactions from cybercriminals. Additionally, the distributed nature of blockchain makes it challenging for cybercriminals to access or alter data.
• Transparency: All transaction data is accessible to every node or participant in the blockchain, allowing them to verify identities and transaction information without intermediaries.
• Consensus-based: Blockchain operates on consensus algorithms, where all relevant network participants must agree that a transaction is valid for it to be appended to the blockchain.
• Flexibility: Blockchain can be customized to suit different needs. It can be completely open to the public or private, allowing only certain individuals access to data or transactions.

While blockchain technology offers numerous benefits, it also has some drawbacks and limitations. One challenge is the adoption of the technology, as financial institutions would need to abandon their current networks and start anew. Blockchain technology is also energy-intensive and costly, especially in the case of Bitcoin, which requires significant computing power for mining.

Despite these limitations, blockchain has gained widespread attention and is being explored and adopted by various industries, including finance, accounting, travel, and supply chain management.

Research different cryptocurrencies

Researching different cryptocurrencies is an essential step in learning to invest in them. Here are some detailed guidelines on how to research different cryptocurrencies:

• Start with the basics: If you are new to crypto, it is advisable to begin with prominent and well-established cryptocurrencies like Bitcoin and Ethereum. This is because there are numerous easily accessible resources about them on the internet, and they are generally considered safer options. To gain a basic understanding of Bitcoin and blockchain technology, you can read the original Bitcoin Whitepaper by Satoshi Nakamoto and the book "Mastering Bitcoin" by Andreas Antonopoulos.
• Look up information on the project website and read the whitepaper: For smaller or newer coins, information may not be readily available, so it is crucial to conduct thorough research. Start by checking the project's website and whitepaper for essential details. Evaluate the legitimacy of the website by examining its content, privacy policy, terms of use, and external links. Understand the project's industry, market, and the issues it aims to address. Assess whether blockchain technology provides a genuine solution to the specified problems.
• Examine the cryptocurrency's use and problem-solving capabilities: Determine the actual use of the cryptocurrency or token. Evaluate whether it has any real value or is merely an object of speculation.
• Research the token or coin: Find out if it is a token or a coin, and whether it has its own blockchain or is built on an existing chain. Look into the total amount of tokens issued and if there will be a hard cap. Consider the number of tokens held by the company and if there was a pre-sale that allowed some people to accumulate a large amount.
• Study the consensus algorithm: Understand the degree of centralization or decentralization of the cryptocurrency by learning about the consensus algorithm it uses. A more decentralized system is generally preferable.
• Research the team: Investigate the team behind the cryptocurrency. Ensure they have sufficient information about their previous experiences, achievements, and qualifications. Look them up on platforms like LinkedIn and Twitter to gauge their activity and engagement. Reach out to them to assess their dedication and gather additional information.
• Analyze the project's roadmap: Understand the project's short and long-term goals by studying its roadmap. Be prepared for potential delays, especially if the team is starting from scratch. Be cautious if the timeframe seems unrealistic.
• Identify strategic partners: Evaluate the credibility of the project by examining its strategic partners. Quality is more important than quantity when it comes to partners. Look for press releases or external sources that provide information about the nature of the cooperation.
• Research competitors: Understand the project's competitive advantage and weaknesses by researching other cryptocurrencies in the same industry or market.
• Consult external sources: Gather information from news websites, analysts, and other businesses. Try to uncover any negative information the project's developers might not want you to know, such as past security breaches or mishandling of funds.
• Leverage social media: Assess the project's social media presence and user engagement. Observe the general sentiment and community atmosphere surrounding the project. Be cautious of overly emotional or hyped-up communities.
• Check Github: If the project claims to be open source, it should have its code posted on Github. Check the insight page to see how many contributors there are and when the code was last updated.
• Understand how and where to buy: Learn about the purchasing process for the token or coin. Assess the risks associated with buying from small exchanges or sending money directly to a contract. Consider the potential for price manipulation by individuals holding a large amount of the cryptocurrency.
• Evaluate market cap: A small market cap means the price can be easily manipulated by those holding a large amount.
• Assess hardware wallet support: Find out if the cryptocurrency is supported by hardware wallets like Ledger or Trezor, which are generally considered more secure.
• Summarize and evaluate your findings: After gathering information from various sources, create a list of pros and cons for the cryptocurrency. Weigh the arguments for and against investing in it.

Compare hot and cold wallets

When investing in cryptocurrencies, it is essential to keep your private keys safe. There are two primary means of storing and exchanging cryptocurrencies: hot wallets and cold wallets.

Hot wallets are software-based wallets that are typically connected to the internet. They are convenient for regular transactions, as they allow users to store, send, and receive tokens from anywhere. However, their frequent online presence makes them more vulnerable to online attacks. Hot wallets are commonly used by those new to the crypto world due to their ease of use and accessibility.

Cold wallets, on the other hand, are hardware-based and offline. They are used for secure, long-term storage of cryptocurrencies. Cold wallets are less vulnerable to online attacks since they are not connected to the internet or another device. However, their offline nature makes them less convenient for regular transactions. Cold wallets are better suited for investors who plan to hold assets for the long term and prioritise security over convenience.

To use cryptocurrencies stored in a cold wallet, you need to connect the wallet to an online device, transfer the necessary amount to a hot wallet, and then make your transaction. Cold wallets usually come in the form of physical devices, such as USB sticks, thumb drives, or smart cards, and typically cost between $50 and $250.

The choice between a hot wallet and a cold wallet depends on individual needs and preferences. A combination of both can also be used, with a hot wallet for regular transactions and small amounts of cryptocurrencies, and a cold wallet for storing larger amounts for the long term. This way, you can enjoy the convenience of a hot wallet while benefiting from the added security of a cold wallet.

Read white papers

Reading white papers is a crucial step when considering investing in a cryptocurrency. A white paper is a document released by developers that explains the technology and purpose of the project they are working on. It tells prospective investors how the cryptocurrency was conceived, highlights its purpose, and contains various forms of data like statistics, diagrams, and formulas. The goal of this data is to convince prospective investors to invest in that cryptocurrency.

• Understand the problem the project is trying to solve: Every project white paper will have a motivation behind its creation. It will usually be at the start of a white paper and give you an understanding of the problem the project aims to address and how its solution differs from existing ones.
• Figure out the project's real-world utility: This is crucial for a crypto token or project. Many crypto coins will have a utility or function beyond simply being a currency. Some can be used for project governance, while others can be non-fungible tokens that grant ownership rights.
• Consensus mechanism: This is a critical aspect of the white paper. There are different consensus mechanisms to consider, such as proof of work and proof of stake. Consensus is essential because it tells how different nodes in the network can determine if a transaction is true or false without direct communication.
• Initial coin distribution: Check how the initial coins were distributed. In proof-of-stake projects, crypto projects may have initial token distributions using pre-mined coins. Sometimes, a significant portion of the initial coins is offered to venture capitalists and project developers, which could be a sign of a pump-and-dump scheme.
• Technical explanation: Projects will often simplify the explanation of how the network functions using graphs and summaries. Focus on understanding the big picture rather than getting caught up in minor technical details.
• Project timeline: The timeline will outline the working plan for the upcoming months, including details like when sales will start and when the token will be launched. A detailed timeline can indicate the developer's competence and foresight.

Remember, while reading white papers is essential, it's also crucial to consider factors outside of the white paper, such as the development team's background and tokenomics.

Practice with test transactions

Testing transactions on blockchain networks is crucial for ensuring the security and seamless functionality of cryptocurrencies, wallets, and networks. Test transactions are a great way to ensure protection from address-poisoning scams and can give you peace of mind before moving forward with a transaction.

Understanding the Basics of Blockchain Testing

Blockchain technology is transforming the way financial transactions are conducted, playing a crucial role in reducing the gap in financial inclusion. However, blockchains rely on multiple data sources instead of a central repository, presenting unique testing challenges. The immutable nature of blockchain data means that data cannot be altered or deleted after entry, making testing complex. Test transactions on blockchain applications have limited testing scope, restricting comprehensive evaluation of various scenarios and error states. Additionally, transaction timelines can vary due to network congestion and consensus mechanisms, requiring a nuanced understanding of the specific blockchain technology.

Implementing Effective Testing Strategies

To overcome these challenges, it is recommended to implement automated testing for efficiency and consistency. Test automation streamlines the testing workflow, optimizes resource utilization, and reduces testing time. Conducting real-world tests with real transactions and devices in users' locations is also crucial to ensure global accessibility and convenience. Regular security audits are essential to detect potential vulnerabilities and enhance the safety of user assets. Collaborating with experts in the field can provide valuable feedback and insights, fostering innovation and enhancing the effectiveness of the testing process.

Verifying Key Aspects of a Crypto Wallet Transaction

When testing a cryptocurrency transaction, it is important to cross-check several data points against the broadcast to the network. A block explorer, a website that allows users to search for transactions on the blockchain, can be a valuable tool. Here are five main aspects to verify:

• Cryptocurrency addresses: Crypto addresses are created by the wallet and tied to a private key stored on the user's device. Addresses are publicly available but not linked to personal information. On some networks, addresses remain static, while on the Bitcoin network, addresses are intended for single-use, with new addresses created automatically after each transaction to maintain user privacy.
• Transaction accuracy: Verify that transactions are registered properly on the blockchain and with the expected receive destination. Check that the amounts are as expected at every step of the process.
• Block confirmations: Blockchain transactions need to be confirmed before finalization. Wallets may have rules about displaying transactions as pending or completed based on the number of block confirmations. As the number of confirmations grows, it indicates more independent sources have agreed that the transaction is valid.
• Transaction fees: Each digital currency has its own fee structure. For example, on the Ethereum network, fees are paid in Ethereum, not in the token being sent.
• Memos or tags: Certain tokens require additional information for routing transactions correctly. For instance, Ripple's XRP uses a destination tag.

Frequently asked questions