Cryptocurrency Investment: Where Does Your Money Go?

Cryptocurrency is a digital or virtual currency that uses cryptography to secure transactions. It is not issued or regulated by a central authority, like a government or bank, but by a decentralized system. The first cryptocurrency, Bitcoin, was founded in 2009 and remains the most well-known and widely used.

Cryptocurrency can be bought and sold on exchanges, or through brokers, apps, and financial derivatives. It can be stored in hot wallets, which are always connected to your computer and the cryptocurrency network, or cold wallets, which are offline devices.

Cryptocurrency is considered a risky investment due to its volatility and the potential for scams and hacks. However, it has produced high returns for some investors.

How to buy cryptocurrency

There are several ways to buy cryptocurrency, each with its own advantages and disadvantages. Here is a step-by-step guide on how to buy cryptocurrency:

Choose a Broker or Crypto Exchange

Firstly, you need to pick a broker or a crypto exchange. While both allow you to buy crypto, there are some key differences. A cryptocurrency exchange is a platform where buyers and sellers meet to trade cryptocurrencies. Exchanges often have low fees but can be intimidating for new crypto investors due to their complex interfaces. Some popular cryptocurrency exchanges include Coinbase, Gemini, and Binance.US. On the other hand, cryptocurrency brokers simplify the process of purchasing crypto but often charge higher fees. Examples of crypto brokers include Robinhood and SoFi.

Create and Verify Your Account

Once you have chosen a cryptocurrency broker or exchange, you need to sign up and create 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 usually involves submitting a copy of your driver's license or passport.

Deposit Cash to Invest

The next step is to deposit money into your crypto account. You can do this by linking your bank account, authorizing a wire transfer, or using a debit or credit card. It's important to note that using a credit card to deposit money can be risky and expensive due to higher interest rates and additional fees.

Place Your Cryptocurrency Order

Once you have funds in your account, you can place your first cryptocurrency order. There are hundreds of cryptocurrencies to choose from, including well-known ones like Bitcoin and Ethereum, as well as lesser-known options. You can enter the ticker symbol of the cryptocurrency you want to purchase and specify the number of coins. With most exchanges and brokers, you can also buy fractional shares of cryptocurrency.

Select a Storage Method

Finally, you need to choose a storage method for your cryptocurrency. Cryptocurrency exchanges typically provide a crypto wallet attached to the exchange, but you may want to transfer your crypto to a separate hot or cold wallet for added security. Hot wallets are stored online and are convenient but carry a higher risk of theft. Cold wallets, on the other hand, are not connected to the internet and offer a more secure option but come with the risk of losing your cryptocurrency if the device fails or the keycode is lost.

Other Ways to Buy Cryptocurrency

In addition to the steps outlined above, there are alternative ways to buy cryptocurrency:

• Traditional trading platforms: Many traditional trading platforms that offer stocks, options, and other conventional assets now also offer crypto. The buying process is similar to purchasing stocks, and investors can use limit orders or market orders to enter the market.
• Mobile payment services: Some mobile payment apps allow users to buy crypto directly from their smartphones. However, these apps usually don't allow the withdrawal of crypto to a private or cold wallet, and the fees can be higher.
• Alternative platforms: You can also use online platforms to buy crypto with a credit or debit card, but these transactions often come with high fees. Another option is to use Bitcoin ATMs, which are physical kiosks that allow you to buy crypto with a credit or debit card. However, these transactions also tend to have high fees.

Crypto wallets

Hot Wallets

Hot wallets are digital tools that are always connected to the internet. They can be accessed from a phone, desktop, or web browser, making them highly convenient for frequent traders. However, their constant online connection also makes them more vulnerable to cyberattacks and hacking attempts. Examples of hot wallets include:

• Coinbase Wallet
• MetaMask
• Trust Wallet
• Electrum
• BlueWallet
• Exodus
• Crypto.com

Cold Wallets

Cold wallets, on the other hand, are designed to store your digital keys offline, either on a hardware device or a physical medium like paper. They provide an extra layer of security as they are not connected to the internet. However, they are less convenient for frequent transactions and are more prone to loss or damage. Examples of cold wallets include:

• Ledger Nano S Plus
• KeepKey
• SafePal
• Ellipal Titan

When choosing a crypto wallet, it is essential to consider factors such as security, functionality, and cost, as well as the types of cryptocurrencies supported. Additionally, it is important to remember that crypto wallets do not actually store your crypto; instead, your holdings live on the blockchain, and the wallet keeps your private keys protected and accessible.

Crypto staking

The first step is to choose a cryptocurrency that supports staking. Not all cryptocurrencies do. Next, you need to acquire the cryptocurrency through a crypto exchange. Then, you select a staking platform and stake your cryptocurrency by locking it to a blockchain network for a predefined time period. Finally, you earn rewards in the form of more crypto.

Active vs. Passive Staking

Active crypto staking involves locking your tokens to a network to actively participate in the network. Active participants may validate transactions and create new blocks to earn token rewards. Passive crypto staking simply involves locking your tokens to a blockchain network to help keep it secure and operating efficiently. Passive staking generally yields lower token rewards than active staking.

Types of Crypto Staking

There are several types of crypto staking, including:

• Delegated staking: Stakers delegate their staking power to a validator node operated by someone else, and rewards are shared among validators and delegators.
• Pool staking: A group of coin holders combine their resources to compete for staking rewards, which are then shared proportionally among the members of the pool.
• Exchange staking: Cryptocurrency exchanges offer staking services, handling the staking process and distributing rewards to participants.
• Liquid staking: Users receive representative tokens that can be traded or used in exchange for staking their crypto.

Pros of Crypto Staking

• The opportunity to earn passive income on crypto assets you plan to hold for the long term.
• The potential for rewards to appreciate in price.
• Staking improves network security and efficiency.
• It may enable your active participation in the blockchain network.

Cons of Crypto Staking

• Your assets have limited or no liquidity during the staking lockup period.
• Staking rewards and staked tokens can lose value when prices are volatile.
• Your cryptocurrency can be slashed (partially confiscated) for violating network protocols.
• When many users receive staking rewards, there is a risk of cryptocurrency inflation.
• An attack on a blockchain network can impact your staked crypto.
• Crypto staking is not well-regulated.
• Successful staking may require advanced technical knowledge.

Crypto regulation

The regulatory status of cryptocurrencies varies across the world. In the US, the SEC regulates the sector, and the body has a lengthy list of filings against crypto-centric businesses and projects. However, the fight between regulators, broker-dealers, investors, and the crypto industry is ongoing, and the US is still evolving in its approach.

In the European Union, the Markets in Crypto-Assets Regulation (MiCA) was introduced in 2023, increasing consumer protections and establishing explicit industry conduct. Crypto service providers must also comply with the EU's Fifth and Sixth Anti-Money Laundering Directives (5AMLD and 6AMLD).

In the UK, crypto assets are recognised as regulated financial instruments, and crypto derivatives trading is banned. Crypto exchanges and custodian wallet providers must comply with the reporting obligations of the Office of Financial Sanctions Implementation (OFSI).

Australia is taking steps towards regulating crypto, with a framework expected to be introduced in 2024. Crypto is recognised as legal property in the country and is subject to capital gains tax.

Canada has been proactive in its approach to crypto regulation, being the first country to approve a Bitcoin exchange-traded fund (ETF). Crypto investment firms are classified as money service businesses (MSBs) and must register with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC).

Japan has a progressive approach, recognising cryptocurrencies as legal property under the Payment Services Act (PSA). Crypto exchanges must register with the Financial Services Agency (FSA) and comply with AML/CFT obligations.

China has banned cryptocurrency exchanges, transactions, and mining within its borders, but has a Central Bank Digital Currency (CBDC).

Overall, the global approach to crypto regulation is varied, with some countries embracing it and others remaining hesitant.

Crypto as a long-term investment

Cryptocurrency is a digital currency that is not issued or backed by any central authority or bank. It is a relatively new technology that has become an accepted part of the global financial system.

Long-Term Investment Strategy

Investing in cryptocurrency for the long term means buying and holding for extended periods, from years to decades. This strategy is based on the belief that the chosen crypto will gain wider adoption and attract more users over time.

• Build Wealth Over Time: Long-term crypto investing is suitable for those seeking to build wealth gradually. It may not be ideal for those seeking short-term profits.
• Less Active Management: With long-term crypto investing, you don't need to constantly monitor price fluctuations, unlike short-term trading.
• Potential for High Rewards: Cryptocurrency has the potential for substantial returns. For example, a $1,000 investment in Bitcoin in 2010 would be worth over $200 million today.
• Research and Due Diligence: It is crucial to thoroughly research any cryptocurrency before investing. Understand the underlying technology, the team behind the project, and the potential use cases.
• Diversification: Diversifying your crypto portfolio can help manage risk. Invest in multiple cryptocurrencies with strong fundamentals and diverse use cases.
• Understanding Risk and Volatility: Cryptocurrency is a highly volatile and risky asset class. Long-term investors should be prepared for significant price fluctuations and potential losses.
• Regulatory and Tax Considerations: Stay informed about regulatory changes and their potential impact on crypto prices. Additionally, be mindful of the tax implications of crypto investments, as they are typically taxed as property or capital gains.

Popular Cryptocurrencies for Long-Term Investment

• Bitcoin (BTC): The oldest and most well-known cryptocurrency, often referred to as 'digital gold'. It has a fixed supply of 21 million, limited by its underlying code.
• Ethereum (ETH): The second-largest cryptocurrency, known for its smart contracts and NFT capabilities. Ethereum has a growing ecosystem of decentralised applications.
• Cardano (ADA): A peer-reviewed blockchain platform that allows users to interact with decentralised protocols and NFTs. Cardano is known for its rigorous research-driven approach to upgrades.
• Polkadot (DOT): A unique cryptocurrency that enables interoperability between different blockchains. It may play a crucial role in the future of Web3.
• Avalanche (AVAX): A blockchain platform that supports NFTs, DeFi, and is EVM-compatible. Avalanche offers fast transaction speeds and low fees.

Tips for Long-Term Crypto Investors

• Dollar-Cost Averaging: Consider making regular, small investments over time, rather than a single large investment. This strategy helps to smooth out the impact of price volatility.
• Understand the Technology: Take the time to learn about blockchain technology, consensus mechanisms, and smart contracts. This knowledge will help you evaluate the potential of different crypto projects.
• Security and Storage: Safely store your crypto in secure wallets or with trusted custodial services. Keep your private keys secure and consider using a hardware wallet for added protection.
• Risk Management: Never invest more than you can afford to lose. Crypto investing is risky, so ensure you have adequate emergency funds and diversify your overall investment portfolio.

Remember, the cryptocurrency market is highly volatile and subject to rapid changes. Always conduct thorough research and consult with a financial advisor before making any investment decisions.

Frequently asked questions