Cryptocurrency has existed as an asset class for barely more than a decade, but the oldest tokens like Bitcoin, XRP, and Ethereum have already experienced meteoric rises and stunning declines. Early crypto investors who withstood the ups and downs have been handsomely rewarded, but those who are just getting started now don’t have the same advantages. Cryptocurrency risks and benefits are different today, and understanding the pros and cons of this new financial system is crucial for successful investing.
How Does Crypto Investing Work?
Cryptocurrencies are built on blockchain technology, a digital ledger that enables different parties to buy and sell without needing a centralized authority like a bank or government to process the transaction. These decentralized currencies solve the trust problem between market participants by creating an unalterable ledger containing all transaction data. (make link rel=nofollow) Crypto miners maintain the records, and rewards systems incentivize them to process transactions quickly and correctly through rewards systems.
To invest in crypto, you’ll need an account at a cryptocurrency exchange, some fiat currency to trade for digital assets, and an investment strategy for your crypto portfolio. Digital currencies are volatile assets with almost no regulation governing them, so a cautious approach is required, especially for new investors.
What are the Benefits of Investing in Cryptocurrency?
- Potential for Large Gains - Let’s be honest; speculation is the primary driver of most cryptocurrency investing right now. The ability to make impressive gains in short periods attracts investors of every experience level. Of course, crypto investing means dealing with painful bouts of volatility, but the upside is hard to ignore. For example, Bitcoin gained 1700% between March 2020 and March 2021; few other assets offer this potential.
- Uncorrelated to Most Other Asset Classes - Diversification is an essential investing discipline, and finding assets that don’t move in lockstep will keep a portfolio from becoming unnecessarily risky. Cryptocurrencies aren’t connected to real-world business cash flows and usually don’t follow the same path as traditional assets like stocks and bonds. Recently, crypto and technology stocks have been moving in similar patterns, but that’s likely due to institutional investors viewing cryptocurrency as a risk-on asset.
- Ability to Earn Interest - Money in a bank savings account will earn little interest. Even the most generous savings accounts rarely top an(make link rel=nofollow) APY of 2%. One of the unique benefits of investing in cryptocurrency is the ability to stake your coins and earn interest rates far superior to traditional bank accounts. Staking cryptocurrency does involve more risk than putting cash into a savings account, and some brokers offering sky-high rates were later accused of being frauds. But reputable crypto brokers still provide much higher interest rates than banks.
What are the Risks of Investing in Cryptocurrency?
- Extreme Volatility - You can’t discuss cryptocurrency risks and benefits without mentioning volatility. Even cryptocurrencies with multi-billion dollar market caps like Bitcoin and Ethereum experience many ups and downs. Moves of 10% or more aren’t uncommon, and small coins with less volume can often double (or be halved) in a single day.
- Extended Bear Markets - Bear markets are unpleasant in any asset class, but cryptocurrency bear markets can be brutal. After peaking in the fall of 2021, most major cryptocurrencies suffered massive declines, with Bitcoin and Ethereum losing over 75% between November 2021 and June 2022. Smaller tokens like Solana fared even worse, losing 90% of their value from peak to trough. Crypto investing is not for the faint of heart.
- Scams and Hackers - When you combine outsized returns and a lack of regulatory oversight, the emergence of con artists is practically inevitable. Unfortunately, many investors have lost their portfolios due to scams, phishing attacks, or rug pulls. And unlike investors in the public markets, there’s no FDIC or SIPC to come to the rescue - when crypto is stolen, it's often gone for good with no recourse for the victim.