Crypto Investing: Understanding The Basics Of Cryptocurrency Investments

Investing in cryptocurrency, or crypto, is a hotly debated topic. Cryptocurrency is a digital currency that can be used to buy goods and services or traded for a profit. Bitcoin is the most widely used cryptocurrency. Crypto is built using blockchain technology, which is a networking protocol that allows computers to work together to keep a shared, tamper-proof record of transactions. Crypto is not backed by real assets or tangible securities and is not regulated like traditional financial products. This means that investing in crypto can be very risky. However, it can also be very lucrative, with some people making millions. Crypto is also very volatile, with huge swings in price happening very quickly. For these reasons, it is generally recommended that crypto only makes up a small part of a diversified investment portfolio.

How to buy cryptocurrency

Choose a Broker or Crypto Exchange

First, you need to pick a broker or a crypto exchange. While both allow you to buy crypto, there are some differences. A cryptocurrency exchange is a platform where buyers and sellers meet to trade cryptocurrencies. Exchanges often have relatively low fees, but they tend to have more complex interfaces with multiple trade types and advanced performance charts, which can be intimidating for new crypto investors. Some popular cryptocurrency exchanges are Coinbase, Gemini, and Binance.US. Cryptocurrency brokers, on the other hand, offer user-friendly interfaces that interact with exchanges for you. Some well-known crypto brokers are Robinhood and SoFi.

Create and Verify Your Account

Once you've chosen a cryptocurrency broker or exchange, you can sign up and open an account. Depending on the platform and the amount you plan to buy, you may need to verify your identity to prevent fraud and meet regulatory requirements. This may involve submitting a copy of your driver's license or passport, or even uploading a selfie.

Deposit Cash to Invest

The next step is to deposit money into your crypto account. You can typically do this by linking your bank account, authorizing a wire transfer, or using a debit or credit card. However, be cautious when using a credit card, as credit card companies process cryptocurrency purchases as cash advances, resulting in higher interest rates and additional cash advance fees.

Place Your Cryptocurrency Order

Once you have funds in your account, you're ready to place your first cryptocurrency order. There are hundreds of cryptocurrencies to choose from, including well-known names like Bitcoin and Ethereum, as well as lesser-known options. You can enter the ticker symbol of the cryptocurrency you want to purchase, such as BTC for Bitcoin, and specify the number of coins you'd like to buy. Keep in mind that with most exchanges and brokers, you can purchase fractional shares of cryptocurrency.

Select a Storage Method

It's important to choose a secure storage method for your cryptocurrencies. Cryptocurrency exchanges typically provide a crypto wallet for storage, but you may want to consider transferring your crypto off the exchange to a separate hot or cold wallet. Hot wallets are stored online and are convenient, but they are more susceptible to theft since they are connected to the internet. Cold wallets, on the other hand, are not connected to the internet and are considered more secure. They come in the form of external devices like USB drives or hard drives, but it's crucial to keep your keycode safe, as losing it could result in losing your cryptocurrency.

Risks of investing in cryptocurrency

Investing in cryptocurrencies comes with a substantial degree of risk. Here are some of the critical risks to consider before investing:

Volatility and Manipulation

The cryptocurrency market has experienced wild swings, with epic booms, busts, and unprecedented gains and losses. This volatility is driven by sentiment, speculation, and market manipulation. The unregulated and anonymous nature of digital asset markets, combined with the susceptibility of cryptocurrencies to sentiment, emotion, and publicity, makes prices volatile. Crypto exchanges, media owners, and influential investors can manipulate prices, and the widespread use of strategies like wash trading, dark pool trading, pump and dumps, and shilling further contributes to price volatility.

Regulatory Uncertainty

The lack of clear regulatory frameworks creates uncertainty for investors. Cryptocurrencies are currently unregulated by governments and central banks, but this is starting to change as authorities in many jurisdictions are introducing new regulations. The classification of cryptocurrencies as a currency or a financial asset has significant implications for taxation, and the regulatory landscape can quickly change, impacting the value of cryptocurrencies.

Cybersecurity Threats and Human Error

Cryptocurrency exchanges face constant cybersecurity threats, and while platforms like Coinbase, Binance, and Kraken have robust security measures, they are still vulnerable to hacking or other malicious activities. Additionally, human error, such as losing private keys or making mistakes when sending transactions, can result in the loss of cryptocurrency holdings.

Limited Market Adoption and Institutional Involvement

The cryptocurrency market has low market adoption due to regulatory concerns, technology shortfalls, public misunderstandings, and the emerging nature of the technology. This limited adoption, coupled with the lack of institutional involvement, could hinder the broad adoption of this new asset class, leading to a potential loss of value.

Centralization and Governance Risk

While blockchains and cryptocurrencies are decentralized, the business entities issuing them may not be. Some cryptocurrency projects, like Tether (USDT) and Binance Coin (BNB), are controlled by a core business entity rather than token holders. This centralization introduces risks of mismanagement, divergence of interests between developers and investors, and the possibility of malicious team members attacking the network from within.

In conclusion, investing in cryptocurrencies is a highly speculative endeavour with significant risks. Investors should carefully consider these risks, educate themselves about the market, and only invest what they can afford to lose.

How to store cryptocurrency

Storing cryptocurrency safely requires a more in-depth knowledge of crypto than simply acquiring it. Here are some detailed instructions on how to store your cryptocurrency securely:

Types of Cryptocurrency Wallets

There are five distinct categories of cryptocurrency wallets: paper, hardware, cloud, multi-signature, and online.

• Paper wallets are generally classified as cold storage, referring to a physical copy or paper print of your public and private keys. It is not recommended to keep large amounts of cryptocurrency on a paper wallet.
• Hardware wallets are external devices like USBs that store your private keys offline. They are considered the safest means of storing crypto assets and are capable of making online payments. Popular hardware wallets include Ledger, Trezor, and Ellipal.
• Cloud wallets are online wallets that can be accessed from any device or location. They are vulnerable to attacks and theft since they store your private keys online.
• Multi-signature wallets are an advanced way to distribute your private keys among different peers, providing an extra layer of security.
• Online wallets are hot wallets that can be accessed at any time but are more susceptible to hacking attempts.

Best Practices for Storing Cryptocurrency

• Use a combination of cold and hot wallets. Cold wallets, such as hardware wallets, are ideal for long-term holding of large amounts of crypto. Hot wallets are convenient for frequent trading and transactions.
• Always enable two-factor authentication (2FA) for added security.
• Choose a strong pin code or password for your hardware wallet that is difficult to guess.
• Never share your private keys, recovery seed phrase, or backup codes online or with anyone. Keep them offline and in a secure location.
• Be cautious of phishing and smishing attempts. Verify the legitimacy of websites and emails before providing any sensitive information.
• Avoid storing your crypto on exchanges or online platforms for prolonged periods. Preferably, use self-custodial wallets.
• Regularly back up your private keys and seed phrases, and store them in multiple secure locations.
• Keep your software and operating systems up to date to patch security vulnerabilities.
• Use a secure Wi-Fi connection when accessing your crypto accounts or wallets. Avoid public Wi-Fi networks.
• Separate your funds and use multiple wallets to minimise the impact of potential security breaches.

How to sell cryptocurrency

There are several ways to sell cryptocurrency, each with its own unique processes and considerations. Here is a step-by-step guide on how to sell cryptocurrency:

Step 1: Choosing a Selling Method

The first step is to select a suitable method for selling your cryptocurrency. Various options are available, including:

• Bitcoin Wallet Apps: These apps allow you to buy, sell, and manage your cryptocurrencies. Examples include the Bitcoin.com Wallet app.
• Bitcoin Exchange Services: These services provide a platform for buying and selling cryptocurrencies.
• Centralized Exchanges (CEXs): CEXs are popular trading platforms that offer a wide range of cryptocurrencies and features.
• Bitcoin ATMs: Bitcoin ATMs enable you to buy and sell Bitcoin directly, similar to traditional ATMs.
• Peer-to-Peer (P2P) Trading: This method involves direct transactions between individuals without an intermediary.
• Using a Brokerage: Brokerages, such as eToro, allow you to create an account and trade cryptocurrencies.

Step 2: Security and Verification

When choosing a method, consider the security measures and verification processes involved. For example, the Know Your Customer (KYC) verification process requires providing personal information to comply with regulations. Additionally, strong passwords, two-factor authentication, and other security measures are essential to protect your crypto assets.

Step 3: Connecting Payment Methods

To sell your cryptocurrency, you will need to connect a payment method. This could be done by linking your bank account, debit card, or credit card. Ensure that the platform you choose supports your preferred payment method.

Step 4: Understanding Fees and Prices

Different platforms and methods will have varying fees and prices associated with selling cryptocurrency. Be sure to review the fees and pricing structure before proceeding. Some platforms may charge a spread markup, transaction fees, or other costs.

Step 5: Executing the Sale

Once you have selected a platform, completed the necessary verification, and connected your payment method, you can proceed with the sale. Follow the instructions provided by the platform to sell your cryptocurrency.

Step 6: Storing or Withdrawing Funds

After selling your cryptocurrency, you may choose to store your funds on the exchange or in a crypto wallet for future trades. Alternatively, you can withdraw your funds to your bank account or another payment method.

It is important to note that selling cryptocurrency, just like buying it, carries risks. The value of cryptocurrencies can be highly volatile, and there are no government or third-party controls to provide stability. Therefore, it is crucial to understand the market dynamics and make informed decisions when selling your crypto assets.

Crypto legal and tax issues

The legal and tax issues surrounding cryptocurrencies are complex and constantly evolving. As cryptocurrencies gain wider acceptance and use, tax professionals and investors need to be aware of the regulatory landscape and their obligations. Here are some key considerations:

• Classification of Crypto Assets: Crypto assets are generally treated as property for tax purposes in many countries, including the US and the UK. This means that capital gains taxes apply when crypto is sold or exchanged, and income taxes may apply when it is earned as payment for goods or services.
• Taxable Events: Not all crypto transactions are taxable. Buying and holding crypto with fiat currency is typically not taxable until it is traded, spent, or sold. However, taxable events include selling, trading, spending crypto, earning crypto through mining or staking, and receiving crypto through airdrops or hard forks.
• Reporting Requirements: In most jurisdictions, crypto transactions must be reported on tax returns. For example, in the US, taxpayers must answer a digital asset question on Form 1040, 1040-SR, or 1040-NR, disclosing whether they received or disposed of digital assets during the tax year.
• Capital Gains and Losses: Capital gains taxes apply to the disposal of crypto assets, such as through selling, trading, or spending. The tax rate depends on the duration of holding the asset (short-term vs. long-term) and the taxpayer's income level. It is important to calculate the cost basis and fair market value of the crypto at the time of the transaction to determine the gain or loss accurately.
• Income Tax: Earning crypto through mining, staking, providing goods or services, or receiving it as a reward is typically taxable as income. The market value of the crypto at the time it is received determines the tax burden.
• Gifts and Donations: Gifting crypto may be subject to gift taxes if it exceeds certain thresholds. However, donating crypto to a registered charitable organization is generally tax-deductible, with specific rules depending on the amount donated.
• Regulatory Landscape: The regulatory landscape for crypto is rapidly evolving, with federal agencies in the US, the UK, and other jurisdictions taking actions to classify and regulate cryptocurrencies. Tax professionals and investors need to stay updated on these changes to ensure compliance.
• Decentralized Finance (DeFi): The tax treatment of DeFi transactions can be complex due to the diverse range of activities involved, such as lending, staking, and earning interest. Tax professionals should advise clients on the potential tax implications of engaging in DeFi activities.
• International Considerations: The tax treatment of crypto may vary across different countries. For example, some states in the US do not impose sales tax on crypto transactions, while others treat crypto as equivalent to cash for tax purposes.

Frequently asked questions