Crypto Investment: What To Expect When You Invest

Investing in cryptocurrency has become increasingly popular in recent years, with some people making large amounts of money. However, it is a risky endeavour due to the volatility of the market, the potential for fraud, and the lack of regulation. Cryptocurrency is a digital payment system that doesn't rely on banks to verify transactions. It is typically stored in a digital wallet and can be used to buy goods and services or traded for profit. When investing in crypto, it is important to diversify your portfolio, prepare for volatility, and only invest what you can afford to lose.

Crypto volatility and risk

Cryptocurrency is widely considered a risky investment due to its volatility and other factors. Volatility is a measure of how much the price of an asset has fluctuated over time. Generally, the more volatile an asset is, the riskier it is as an investment. Crypto is a newer asset class and is considered highly volatile, with the potential for significant upward and downward movements over short periods.

Causes of Volatility in Crypto

Crypto asset prices are often influenced by market speculation, driven by hype and the elements of fear, uncertainty, and doubt (FUD). This volatility can be accentuated by limited liquidity, resulting in pronounced price changes during significant trading shifts. Regulatory changes, cybersecurity breaches, official announcements, news reports, and social media sentiment can also impact the volatile landscape of the crypto market.

Measuring Volatility

Volatility can be measured in a few ways:

• Historical volatility: This is a statistical measure of past price fluctuations, calculated as the standard deviation of an asset's price over a specific time period, often 30 days or a year.
• Implied volatility: This predicts future price movements and is derived from the prices of options contracts.
• Beta: This measures an asset's volatility relative to a benchmark, such as the overall market. A beta greater than 1 indicates higher volatility.

Risks Associated with Crypto

In addition to volatility, there are several other risks associated with investing in crypto:

• Liquidity Risk: Crypto trading platforms may not have enough assets to cover orders, and there are no guarantees of continued demand. Trading may be limited or suspended, and there could be restrictions on funding and withdrawals.
• Online and Cybersecurity Risks: Crypto service providers and intermediaries are often difficult to identify and locate, making it challenging to take action if issues arise. The technology and platforms used for crypto trading are susceptible to cybersecurity threats and hacking, putting funds and assets at risk.
• Regulatory and Legal Risks: Crypto laws and regulations vary across countries, and some nations have even banned it. In the US, while an increasing number of businesses accept crypto as payment, it is not legal tender and is subject to regulatory oversight.
• Fraud and Theft: Crypto exchanges are vulnerable to hacking and other criminal activities, and theft of crypto is a significant concern. The decentralised and unregulated nature of crypto also makes it ripe for fraud.
• Unproven Rate of Return: Crypto has an unproven track record, and its value fluctuations are unpredictable due to the lack of regulations. There is not enough data or credibility to create a long-term investing plan based solely on cryptocurrency.

Managing Crypto Volatility and Risk

While crypto investing carries significant risks, there are strategies to manage these risks:

• Diversification: Spreading investments across a variety of assets, including stablecoins, can reduce the impact of price declines in any one asset.
• Risk Management Tools: Tools like stop-loss orders and options like Bumper can help limit potential losses.
• Volatility Management Tools: Indicators such as Bollinger Bands, Average True Range, and Chaikin Money Flow can provide insights into market dynamics and potential trading opportunities, helping traders make more informed decisions.

Crypto fraud and scams

• Investment scams: These often involve scammers posing as "investment managers" and promising huge returns on crypto investments. They may also use fake celebrity endorsements to lure victims. A common tactic is the pump-and-dump scheme, where scammers hype up a particular coin, causing its price to rise, and then sell their holdings, causing a crash.
• Phishing scams: Scammers send emails or texts with malicious links that lead to fake websites designed to steal login credentials, passwords, and other sensitive information. They may also impersonate well-known companies or government agencies to gain your trust.
• Romance scams: Scammers use dating websites or apps to gain the trust of unsuspecting individuals and then convince them to invest in crypto or send them crypto directly.
• Fake crypto exchanges and wallets: Scammers lure victims with promises of cheap Bitcoin or other cryptocurrencies, often quoting outrageous returns. These platforms are designed to steal your money and personal information.
• SIM-swap scams: Scammers gain access to a copy of your SIM card, allowing them to receive two-step authentication codes and hack into your crypto wallets and other accounts.
• Rug pull scams: Scammers promote a new project, non-fungible token (NFT), or coin to raise funds and then disappear with the money. Investors are left with a valueless investment that they cannot sell.
• Blackmail and extortion scams: Scammers send emails claiming to have compromising information about the victim and threaten to expose them unless they share private keys or send cryptocurrency.
• Ponzi schemes: Scammers lure new investors with promises of huge profits and low risk. They use the money from new investors to pay older investors, creating a circular scheme.
• Fake job offers: Scammers impersonate recruiters or job seekers to gain access to crypto accounts. They may offer interesting jobs that require an upfront payment in cryptocurrency.
• Flash loan attacks: Attackers take advantage of unsecured flash loans (short-term loans with no collateral) to manipulate pricing on decentralized finance platforms and make a profit.

To protect yourself from crypto scams, it's important to be vigilant and follow these precautions:

• Never share your private keys or wallet passwords with anyone.
• Only use reputable crypto exchanges and wallets with a long user history.
• Be cautious of unsolicited contact and avoid responding to unknown senders.
• Verify the legitimacy of any crypto-related website or app before entering sensitive information.
• Do your research before investing in any crypto opportunity, and be wary of excessive marketing or promises of guaranteed returns.

Crypto wallets and storage

Crypto wallets are essential for buying, selling, and storing cryptocurrencies. They are used to store your private keys, which give you access to your coins and allow you to conduct transactions.

There are several types of crypto wallets, each with its own benefits and drawbacks. Hot wallets, for example, are connected to the internet and are usually convenient to use, but they are also vulnerable to online attacks. Examples of hot wallets include web-based, mobile, and desktop wallets. On the other hand, cold wallets, such as paper and hardware wallets, keep your private keys offline and out of reach of online threats.

When choosing a crypto wallet, it is important to consider factors such as security, cost, user experience, supported cryptocurrencies, and customer satisfaction. Some popular options for hot wallets include Exodus, which is great for beginners, and Mycelium, which is a good choice for mobile users. For cold wallets, the Trezor Model T and Ledger Nano X are well-known options that offer enhanced security features.

It is worth noting that while crypto wallets provide a high level of security, improper security practices by the user can lead to a complete loss of funds. Therefore, it is crucial to take necessary precautions, such as using cold storage methods and never sharing your wallet's login details or private keys with anyone.

Crypto ETFs and investment funds

Crypto exchange-traded funds (ETFs) are a developing asset class that tracks the price performance of cryptocurrencies. They allow investors to gain exposure to the crypto market without directly buying, storing, or owning the digital assets themselves. Crypto ETFs trade on regular stock exchanges, and investors can hold them in their standard brokerage accounts.

Crypto ETFs can be divided into two main types:

• Spot ETFs: These directly hold the underlying cryptocurrency, building a portfolio that replicates the performance of the digital assets it contains. Examples include the iShares Bitcoin Trust ETF and the Bitwise Bitcoin ETF Trust.
• Futures ETFs: These invest in futures contracts, which are agreements to buy or sell crypto at a preset date and price. The ProShares Bitcoin Strategy ETF, the first cryptocurrency ETF, is an example of a futures ETF that tracks bitcoin futures prices.

Other types of crypto ETFs include:

• Blockchain ETFs: These invest in companies that are involved with the development and use of blockchain technology, such as the Amplify Transformational Data Sharing ETF.
• Crypto Index Funds: These funds, such as the Bitwise 10 Crypto Index Fund, invest in a basket of cryptocurrencies, usually the top 10 by market capitalisation.
• Inverse ETFs: These generate returns that are the inverse of the underlying cryptocurrency's returns, allowing investors to profit when crypto prices decline. An example is the ProShares Short Bitcoin Strategy ETF.

Crypto ETFs offer several advantages, including:

• Exposure Without Ownership: Crypto ETFs provide exposure to crypto without the additional expenses and risks associated with owning and holding digital assets in a wallet.
• Lowering the Learning Curve: Cryptocurrency jargon and technology can be complex, but investing in a crypto ETF is a simpler way to gain exposure to the market.
• More Security for Investors: Crypto ETFs take care of security concerns, as cryptocurrency exchanges, wallets, and blockchains have been vulnerable to hacks.
• Lower Costs: With thousands of cryptocurrencies available worldwide, buying and selling them can be costly and complex. Crypto ETFs allow for diversification without the fees and hassles of buying tokens directly.

However, there are also some disadvantages to consider:

• The Risk of Tracking Error: Crypto ETFs, especially those based on futures contracts, may not always duplicate the price moves of the underlying digital token.
• Elevated Fees and Expenses: Crypto ETFs often have higher expense ratios than other ETFs due to active management.
• Lack of Direct Ownership: Investors in crypto ETFs do not have control or direct access to the underlying cryptocurrency, and the decentralisation and anonymity of crypto do not apply to ETF shareholders.
• Volatility: Like the crypto market itself, crypto ETFs are subject to dramatic price swings and high volatility.

Crypto taxes

United States Crypto Taxes

In the United States, cryptocurrency is subject to income and capital gains tax. This means that any gains from selling or disposing of cryptocurrency are generally taxed as capital gains, while income earned from cryptocurrency is taxed as ordinary income.

The tax rate on crypto gains depends on the holding period and the taxpayer's income tax bracket. For example, if you held the crypto for less than a year before disposing of it, the tax rate could be between 10-37%. On the other hand, if you held it for more than a year, the tax rate could be between 0-20%.

It's important to note that not all cryptocurrency transactions are taxable. Buying crypto with fiat currency, transferring it between your own wallets, or using it as collateral for a loan are typically considered tax-free transactions.

Additionally, cryptocurrency losses can be used to offset capital gains and even a portion of your income, providing some tax relief.

Brazil Crypto Taxes

Brazil introduced crypto taxes in 2019 and 2020 to regulate transactions. Cryptocurrencies are considered movable goods from a tax perspective, and any profits from selling or exchanging crypto are subject to capital gains tax. The tax rates are progressive, ranging from 15% to 22.5%, depending on the total profit made.

It's important to note that Brazil has specific rules for different types of crypto transactions. For example, swapping one cryptocurrency for another is considered a taxable event, while transferring crypto between wallets is not taxed. Additionally, if you receive a salary in cryptocurrency, it is taxed similarly to receiving payment in fiat currency.

Brazil also has rules regarding the calculation of capital gains and cost basis. Two common methods are First In, First Out (FIFO) and Average Cost Basis (ACB), which take into account the order of acquisition and the average cost, respectively.

India Crypto Taxes

India's Financial Intelligence Unit (FIU) has been pursuing foreign crypto exchanges, including Kraken and Bitfinex, for unpaid Goods and Services Tax (GST). These exchanges were banned from operating in India due to non-compliance with tax laws, and they will need to pay significant fines to resume their services in the country.

India's crypto taxes aim to ensure that foreign exchanges comply with the same GST rules as domestic businesses, paying taxes on the services provided to Indian clients.

Frequently asked questions