The long-term investor would consider the cryptocurrency market to be in its infancy. Unregulated and with very little institutional appeal, the demand for low-cost, cross-border, immutable and programmable money is only just beginning. This technology has not even begun to crawl yet; we are all still very early.
This article assumes that you have already been convinced by the value of this technology – whether in the form of Ethereum, Bitcoin or the blockchain ecosystem more broadly. Now that you have decided to invest – or invest further – this article should hopefully come as a useful guide to the cryptocurrency landscape and some key principles that can be applied for investing for new and experience investors alike. Needless to say, this market is highly volatile, and your capital is at risk.
Note; this article talks about cryptocurrencies and cryptoassets. In this context, they mean the same thing.
Principles of Cryptocurrency Investing
There are a number of things I’ve learned about cryptoccurrency investing over the years but there are three which are really worth noting in order to enter this market with as little misinformation as possible.
- The cult of crypto
- Complex technology
- Binary investing
The possibility of a 10,000%+ return has some (unsurprisingly) strange effects on the human psyche. Be aware of the lengths to which some people will go to “pump” superficial coins with very little fundamental value. A new investor may end up following the first leader who promises riches, often being persuaded by pseudo-scientific language that sounds somewhat impressive. Be wary of marketing strategies and discussions that shy away from technology and instead use vague and emotionally-charged language.
The mainstream media will have you believe that an investment in Ethereum et al is equivalent to an investment in an internet company. This is not particularly accurate. When you invest in a blockchain token like ETH or BTC, you are investing at the protocol level. The approach to valuing the investment opportunity of a protocol is very different from that of a technology stock. At a protocol layer the technology is extremely complex, with – in reality – very few people fully grasping how it works. It is not realistic for investors (myself included) to critique – for example – a low level consensus algorithm. Find developers and technologists that you trust and learn what you can from them.
From speaking to others and following various communities there is an unhealthy level of “binary investing” in this space. For example, a new investor asks the question (and this type of question is asked frequently) “should I invest in Ethereum or Ethereum Classic?”. Other than the desperation to scream “do your own research!”, the implication that the choice is binary confuses me. Investing in cryptocurrency is rarely an “either/or” scenario. If this investor believed in the fundamentals of both ETH and ETC then the answer is simply: both. The real question is how these two assets should be balanced in a portfolio.
Balancing a Portfolio
Before speaking about cryptoassets directly, let’s first take a look at some fundamental considerations that can be used to help determine which cryptoassets to include.
Balancing a portfolio is subjective and largely tied to an investor’s risk tolerance. While the cryptocurrency market as a whole is considered very high risk, the risk spectrum within the market is broad and a balanced asset selection is important. Cryptocurrencies with a higher market capitalization (= coin value multiplied by coin supply) will typically have lower volatility than assets with a low market capitalization. Lower volatility often correlates with lower returns and – as a result – many new investors chase high risk/high return cryptoassets with a low market cap. Across all of these varying coins and market caps are varying risks; one asset may be far more likely to feel the full force of the SEC while another may be launching with radically new technology that could be fraught with bugs.
The term “risk” is thrown around a lot with cryptocurrencies. Everyone knows that investing in crypto is “high risk” but what does that actually mean? Yes, the price will be volatile, but that doesn’t explain the fundamental risk factors that belie these wild price movements.
- Regulatory risk
- Platform risk
By far the most talked about risk today is the risk of heavy-handed regulation from the USA, China, Russia, India and South Korea. Many new investors or those on the sidelines consider all cryptoassets to face the same regulatory risk. This is simply not true. Ripple (XRP), Stellar (XLM) and – to some extent – Ethereum (ETH) are all working alongside regulators and banks to ensure that this technology can continue to evolve somewhat freely. On the other hand, cryptocurrencies like Monero (XMR) and Zcash (ZEC) are focused on privacy. Regardless of your opinion on privacy, it is clear that the risk of regulation here is far greater. Regulatory risk has been eased slightly following comments by the CFTC.
Blockchain technology is nascent and the risk of unforeseen bugs in the code or flaws in the underlying crypto-economics (incentive structures) may lead to major issues in the future. Bitcoin, which has been around since 2009, is by far the most stable cryptocurrency. With a network valuation in the hundreds of billions (the world’s largest “bug bounty“), it is fair to say that the network has demonstrably proven a high level of security. The same cannot be said for other cryptocurrencies which have billion dollar valuations and no live blockchain. Ethereum, which is arguably as secure as Bitcoin at the protocol level, has also faced and held off similar (protocol level) threats. However, unlike Bitcoin, the Ethereum Foundation intends to update the protocol layer on a number of occasions before it is deemed complete. Every upgrade introduces possible risks, and so while Bitcoin does not attempt to achieve the same ambitious goals of Ethereum (blockchain computation), it does have security in its stable and (relatively) unchanging protocol.
We’ve all heard it before; sceptics referring to Bitcoin and Ethereum as the AOL and MySpace of the blockchain era. This analogy once again misses the point. Blockchains compete at the protocol layer and not the application layer. One protocol may successfully supplant another (see TCP/IP vs OSI) but the reasoning is often far simpler than that of complex applications like AOL and MySpace. At the protocol layer, speed and cost are the two most important metrics with critical mass (adoption) also playing a key role. The stage on which competing blockchains battle also varies; Ethereum (smart contracts) does not compete with Bitcoin (payments) and Monero (privacy) does not compete with Augur (oracle). Blockchains that do operate in similar fields – Ethereum, NEO, EOS, Cardano and Lisk for example – will face some level of competition, and in these instances it is unlikely that all platforms survive and prosper. In a situation like this, an investor would do well to avoid the binary approach to crypto investing and instead consider each of them in a portfolio that values the fundamental use cases of smart contracts.
Despite the risks; the previously Bitcoin-sceptic JP Morgan published the “Bitcoin bible” in February 2018 in which it asserted that cryptocurrencies are here to stay. The question now comes down to not “should I invest?” but “what should I invest in?”.
Which cryptocurrencies to buy
When evaluating the investment potential of a cryptocurrency there has to be a strong understanding of what will drive the price upwards. This sounds painfully obvious, but so many new investors purchase utility tokens which fail to meet this simple criteria. The value of a cryptocurrency will increase if it is bought and held for long periods of time with low-inflating or fixed supply (demand and supply economics). If the asset’s usefulness comes in the buying and selling of it instantly, or the supply inflation rate is high and indefinite, then the economics are simply not conducive to price growth. What is it about the technology that would incentivize buying and holding beyond simple price speculation?
Utility vs Blockchain tokens
A blockchain token like Ether or Bitcoin is used as an incentive mechanism to secure the network. Miners are rewarded with tokens on the successful discovery of the next block of transactions. This native token is also used to pay transaction fees. Utility tokens on the other hand are application specific and are required to interface with the app’s platform. The vast majority of utility tokens are built on top of Ethereum of which there are now hundreds. Some of the higher market cap assets include cloud storage tokens like Golem and Storj as well as prediction market tokens Gnosis and Augur. While a number of utility tokens have increased in value dramatically (and many will no doubt continue to do so), their potential demand is much lower than that of a blockchain token like Ethereum whose token is general-purpose and faces large-scale global demand.
Purchasing by sector
The first “killer app” for cryptoassets is payments. Here are a number of others (and their coins) which are – in my opinion – most likely to be heavily disrupted or innovated in the years ahead:
- Store of value – BTC, ETC, XMR
- Private payments – XMR, ZEC
- Identity – CVC, BLT
- Gambling – FUN
- Advertising – BAT
- Smart contracts – ETH, ADA, NEO, EOS …
- Lending – SALT, TRST, LEND
- Oracles – REP
- Oracles – REP
- Decentralized Exchanges – 0x
- Supply chains – VEN, AMB
- Collectibles – MANA
Globally transferable, highly secure and free from confiscation and censorship
Proof of identity and control over one’s data
Greater transparency and fairness, more trust between players and casino with “provably fair” systems
Cheaper transactions, micropayments and transparency
Automated payments based on real world conditions
Micro-loans and peer-to-peer lending without borders tied to blockchain-based identity platforms
Interfacing the real world with the digital world through trusted data. Oracles will form a new industry that is critical for the functioning of smart contracts
Autonomous exchange between cryptocurrencies will be critical for blockchain interoperability and smart contracts
Increasing transparency, reducing costs and improving safety for consumers
The coins above may or may not be a scam. Do your own research!
What does our portfolio look like?
Armed with all of the above information, particularly those around growing sectors and the potential risks, it becomes much easier to decide on which cryptocurrencies to buy. The balance of one’s portfolio should be tied to perceived risk as well as perceived growth. For example, privacy coins have enormous potential growth, but they could well be halted by strict regulation.
High risk portfolio
This portfolio is made up of penny stocks with very little focus on the relatively stable prices of Bitcoin and Ethereum. An investor in agreement about the sectors above (in terms of potential for growth) may choose to find ICOs in these sectors or coins with very low market caps. Returns for a portfolio could be enormous, but equally these tokens may disappear into obscurity.
Lower risk cryptocurrencies
The lower risk portfolio has an emphasis on Bitcoin and Ethereum – as much as 90% – with the remainder distributed to high risk assets that have the potential to increase 10 to 100 times over a short period of time. Those looking for even lower risk portfolios may also want to include equities (not cryptos) that are closely linked to the cryptocurrency markets such as Nvidia and AMD (and more recently – Samsung).
When to invest?
If there is one aspect of cryptocurrency investing that is over-thought and over-discussed, it is the timing of an investment. This guide is focused on the fundamentals of cryptocurrency investing, and as such, considering the short term price movements would be irrelevant. If you believe that the long-term outlook of the tokens you have selected is positive, then there is no better time to invest than the moment you have made that decision.
There is a caveat in that statement, and that is that an unlucky investor’s portfolio could fall by 50% or more overnight. Those who do not want to risk that gut wrenching feeling may wish to “dollar cost average” (buying fixed % chunks over a set time-period). This averages the overall purchasing price and softens any volatile movements (good and bad). Dollar cost averaging does provide some peace of mind, however over the long run its effects are likely to be negligible.
Where to invest?
Deciding on where to purchase cryptocurrency varies depending on the portfolio selected. Once you have decided on the make-up of your portfolio, visit CoinMarketCap.com and navigate to each cryptocurrency individually. From the cryptocurrency page you can select “markets” and this will provide information on the exchanges that trade this cryptocurrency with the most volume for your given currency pair (for Ethereum, that would be ETH/EUR, ETH/USD and so on). It’s possible for someone dealing with Euros to invest in an ETH/USD currency pair as the exchange will do the necessary conversions, however the fees for this will likely make it less appealing. Investing on an exchange with the highest volume in your local currency pair will mean that your order is likely to be settled the quickest and at a price which is closest to the “real” market price of the asset.
Keeping your investment safe
With a cryptocurrency purchase now made, it’s essential that the portfolio is stored securely. Millions of dollars worth of cryptoassets are stolen each year – predominantly from vulnerable exchanges. There are many tools available to investors which will help them store their investment in an ultra-secure manner. Our guide on how to buy Ethereum features a number of principles which cover wallet security for all cryptocurrencies in general.
This article should not be considered investment advice; do your own research and make an informed decision that you are comfortable with.