Cryptocurrencies have been getting a lot of media attention lately and are growing in popularity. In fact, a recent survey found that in fall 2021, nearly 25% of all new investment deposits made included an investment in some form of cryptocurrency.* But even people who are investing in cryptocurrency have a hard time explaining how it works.
It’s a complicated topic, so before you jump on the crypto bandwagon, consider whether cryptocurrency is a good investment for you.
What is cryptocurrency and how does it work?
An alternative to traditional money issued by a government, cryptocurrency is a digital form of currency that can be bought, sold, and spent through secure online transactions. Cryptocurrencies can be held as an investment or used as regular money to buy goods and services.
There are more than 10,000 different types of cryptocurrencies on the market today, and more are being ‘minted’ all the time. Two of the most popular are Bitcoin and Ethereum. Cryptocurrencies can be worth anywhere from pennies to thousands of dollars. Many major cryptocurrencies allow you to purchase a fraction of a coin if desired.
Instead of using traditional channels like a bank or a brokerage, most cryptocurrency is bought and sold through an exchange; two of the most popular exchanges are CoinBase and Crypto.com. To invest in crypto, just choose an exchange, open an account and add a payment method; you can then buy and sell the cryptocurrency directly on the exchange. You can also do the same through an online brokerage such as Robinhood, or even on PayPal.
A record of your secure transaction is stored on something called a blockchain, a decentralized network of computers that serves to track and verify crypto buy and sell transactions. Once you’ve purchased your crypto through the exchange, you can opt to transfer it to a digital or hardware wallet, which provides additional security because it stores the unique digital key of your cryptocurrency ownership.
Unlike traditional money, it can be difficult finding a place to spend your cryptocurrency, although options are continuously being added. Today, most people buy cryptocurrency as an investment.
But unlike traditional investments, cryptocurrency is not insured or regulated by a government agency. Any investments in or purchases made with cryptocurrency are not reversible or disputable, which increases your risk of being scammed.
Why is cryptocurrency so popular?
Cryptocurrency is innovative and exciting. Stories of people becoming ridiculously rich overnight are legendary, making crypto the stuff of dreams for many. Investors like the thought of ‘getting in on the ground floor’ since they expect digital currency to grow in value over time. Cryptocurrency is also popular because it is decentralized, giving investors the opportunity to control and own assets not governed by a financial institution.
Unlike a stock, which is in part tied to the value of the company it represents, the value of a cryptocurrency is tied solely to supply and demand. Crypto gives people a way to diversify their portfolio with a nontraditional investment.
Is cryptocurrency a good investment?
The key to success with investing in cryptocurrency is to remember that it’s a speculative investment—a bet on the future. Your investment in cryptocurrency is based solely on the fact that you think it will increase in value over time. This means that people are typically more likely to buy cryptocurrency as an investment rather than spend it as an actual currency, because of their expectations for growth.
For some, cryptocurrency provides a good way to diversify their portfolio. But keep in mind that crypto is new, and changing all the time, which makes its price extremely volatile. Volatility carries risk, which means you could do well, or you could lose your entire investment.
How to know you’re ready to invest in crypto
While it’s tempting to want to jump in and avoid FOMO (fear of missing out), this is one of those times in life when it pays to be thoughtful and deliberate. Before investing in cryptocurrency, make sure the following are true:
1. You understand how cryptocurrency works
This is a classic investing rule, and one of the best ways to avoid getting scammed. Remember, cryptocurrency has no government oversight, which also means you have no protection if something goes wrong. Know how to protect your digital wallet against hacks, learn about who owns the company before buying a cryptocurrency, and understand what you’re buying—actual tokens, currency, or a stake in a company. If you can’t explain cryptocurrency to your mother, you may not be ready to invest.
2. You’ve done your research
New cryptocurrencies hit the market all the time, so be skeptical. Do your own research and don’t fall for social media hype that promotes sketchy investment opportunities. In your rush to invest, make sure you’re investing in real cryptocurrency.
3. You are in a good place financially
This doesn’t mean that you must wait until you’re wealthy, but you should be able to afford to lose your entire investment. It could and does happen. But, if you’ve got a fully-funded emergency savings account, if you’re already making the maximum contributions to your retirement plan, and if you’re not drowning in debt, you might be ready to play the cryptocurrency market.
4. You can afford to lose your entire investment
This fact cannot be overstated: investment in cryptocurrency is risky. Crypto markets swing wildly, and people lose money every day, sometimes a lot of money. Just make sure you don’t invest more money than you are willing or able to lose.
5. You’re investing in cryptocurrency for the right reasons
Cryptocurrency offers a great way to diversify and add risk to an already well-stacked portfolio; it also provides a means of hedging against inflation. If you can tolerate extreme risk and you believe in the ability of cryptocurrency to have a positive influence on market innovation, then crypto investing might be a fun way for you to engage with this new market.
Is crypto a good idea for you?
If you feel like you understand how cryptocurrency works, you want to diversify your investment portfolio, you are comfortable with risk and you can afford to lose the entire amount invested, you may be ready to invest in crypto. But if market volatility causes you to lose sleep, hit the snooze button and wait a bit.
The purpose of this article is to provide general information about cryptocurrency. It is not intended as investment advice.
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