5 Things You Should Know About Cryptocurrency Before Investing
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In many ways, the cryptocurrency market is unique.
Unlike stocks, which trade during a set time during the day (9:30 a.m. to 4 p.m. EST in the US), crypto markets are open 24/7 and never stop trading.
The barriers to entry are also lower. Whereas opening a brokerage account typically requires some paperwork and identity verification, some crypto exchanges let users register with little more than a name and email address.
While more U.S.-based exchanges like Coinbase are now beginning to require additional steps to verify users and comply with anti-money laundering (AML) and know-your-customer (KYC) laws, it’s still true that almost anyone can trade cryptocurrency coins and tokens at any time.
But just because they can trade crypto, doesn’t mean everyone wants to or should.
Here are five things every potential investor should know before investing capital into this new asset class.
1. What is Cryptocurrency?
First things first. If you want to start investing[Link to Kiplinger Affiliate referrer link] in cryptocurrencies, it may help to have a basic understanding of how it began and how the technology works. Investment experts agree that comprehending the general nature of what you’re investing in is a good place to start.
In 2009, Bitcoin’s pseudonymous creator or creators, Satoshi Nakamoto, published a white paper for what he/she/they called a “peer-to-peer electronic cash system.”
The nine-page lays out the design for a distributed network of computers that can facilitate transactions between each other without a third-party intermediary—in other words, peer-to-peer.
The fact that there are many computers in the network makes it more secure, since there is no single point of failure. The economic incentives of the system are designed in a way that makes it more profitable for people to be honest participants rather than try and engineer attacks against the system.
All subsequent blockchain technologies and cryptocurrencies have been built on variations of the concepts articulated in this nine-page white paper.
2. What Is the Difference Between Bitcoin and Other Cryptocurrencies?
While the term cryptocurrency is broadly used to refer to any type of cryptographic asset, they are not all the same.
A currency like Bitcoin (BTC) has a fixed supply cap and can only be created by sophisticated computer hardware solving complex mathematical problems through a process called proof-of-work (PoW). This process is referred to as mining.
Litecoin (LTC) was created in 2011 by Charlie Lee. LTC is a Bitcoin clone that uses a different encryption algorithm than Bitcoin and has faster transaction times.
Another class of cryptocurrencies are referred to as utility tokens. These are just what they sound like—tokens that are used to do something. For example, ETH, the token of the Ethereum network, is used as “gas” to fuel decentralized applications, or dApps.
There are many other utility tokens as well, most of which host their decentralized applications on the Ethereum network.
There are also other types of tokens, like security tokens, that are newer and still in the experimental phase. New investors should be aware of the general distinction between tokens and mineable cryptocurrencies.
3. How is Cryptocurrency Access Controlled?
At its most basic, cryptography involves two kinds of keys: public keys and private keys.
In the cryptocurrency world, private keys are what signify that a particular user owns a particular amount of Bitcoin or another cryptocurrency. If someone else gets your private key, they can steal your coins.
Why is this important?
Because what makes this asset class special is the decentralized aspect. That means there’s no central authority that controls things, like a bank.
While this might arguably be one of the biggest benefits of the technology, this feature also places an additional responsibility on the individual user to take control of their money.
So, when it comes to private keys, some experts believe it’s better for investors to hold their own. When coins are held on an exchange, the exchange holds the keys. With cryptocurrency, users can take ownership of their private keys. Crypto empowers people to become their own bank.
Using a paper wallet or a hardware wallet, coins can be taken offline and put into what’s known as cold storage, which refers to a method of storing digital assets that can’t be accessed by anyone on the internet until the assets come back online.
While cold storage is an important possibility, it does require some technical know-how. For inexperienced users making smaller investments or trading frequently, it might be better to keep most or all crypto holdings on a trusted exchange.
4. What Is the Right Amount of Cypto in a Portfolio?
Whenever you’re making an investment, it’s wise to ask the question, “how much of my overall investment portfolio do I plan on putting into this particular investment?” The answer to that question determines an investor’s asset allocation.
Some successful investors have said that they have taken a 1% to 2% allocation to Bitcoin. While this may not sound like much, for hedge funds with at least a billion dollars in assets under management, that could equate up to millions.
5. What Are the Tax Implications of Cryptocurrency?
In the US, the IRS considers cryptocurrency to be a type of property. That makes crypto subject to capital gains tax laws.
So, if an investor who buys crypto, holds it for the long term, and never does anything else, they won’t actually owe any taxes.
A taxable event only happens when the cryptocurrency is sold, used to purchase goods or services, used as a form of payment, or exchanged for another cryptocurrency and realizes a capital gain or loss.
Trading Crypto With SoFi Invest®
These five basics can be a good way for investors to gauge their comfort level with cryptocurrency investment.
While there is much more to each of these five topics and the world of cryptocurrency in general, consider this article a preview. Interested investors might want to consider conducting their own research before making informed decisions.
Fortunately, SoFi is here to simplify things (check out our Guide to Crypto). With SoFi Invest®, customers can buy crypto including Bitcoin, Ethereum, and Litecoin, with peace of mind that their investments are held securely.
Learn more about investing in cryptocurrency at SoFi.
The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. Advisory services offered through SoFi Wealth, LLC an SEC-registered investment adviser. SoFi Securities, LLC, member FINRA/SIPC. http://www.finra.org/ & https://www.sipc.org/
Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA (http://www.finra.org/investors/cryptocurrencies), the SEC (https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11), and the CFPB (https://files.consumerfinance.gov/f/201408_cfpb_consumer-advisory_virtual-currencies.pdf), have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments.
Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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