In 2017, the market capitalization of Bitcoin reached more than $230 billion.
Bitcoin is only one of a wide range of different cryptocurrencies. With such huge sums involved, it is clear that big money can be made investing in cryptocurrencies.
With such a volatile investment, you need to know what you’re doing before you start pumping your hard-earned cash into the first cryptocurrency you find.
So read on as we look at 10 things you need to know before investing in cryptocurrencies.
1. What Is Cryptocurrency?
Cryptocurrency is a digital currency that has no physical form. There are no coins or notes; all cryptocurrency exists purely as digital data.
Cryptocurrencies can be exchanged between people, used to pay for goods and services, or traded for other currencies. The key difference from traditional currencies, aside from the lack of physical form, is that there is no government oversight and no banks involved. It was designed to be completely free from outside influence.
To ensure that cryptocurrency isn’t falsified or replicated, it is built on a system known as blockchain.
2. What Is Blockchain?
Blockchain is a method of recording transactions for cryptocurrencies, in such a way that those transactions cannot be erased or altered.
At its heart, blockchain is just a list of transactions. Each time a new transaction occurs, it is added to the list.
The clever part is that this list of transactions is not held in one place. Instead, it is distributed across the internet, making it easy to verify and almost impossible to hack.
By making use of blockchain, cryptocurrencies can be used as securely as physical currencies.
3. What Is Mining?
In order for cryptocurrency transactions to be verified across the database, it requires computer processing power.
Miners try to solve complex mathematical problems with their computers. By solving the problem first, they get the privilege of authenticating the transaction and as a reward earn a small amount of cryptocurrency. The equipment involved in mining does not come cheap, so this isn’t the best route to making your fortune.
4. Is It Just Bitcoin?
Bitcoin is the cryptocurrency that started it all, but it has spawned a range of alternative cryptocurrencies. There are more than two thousand cryptocurrencies currently in existence, and the number is growing all the time.
Not all cryptocurrencies are created equal. Some have grown quickly to have solid reputations, such as Ethereum, Dash, EOS, and Litecoin. Many cryptocurrencies have their own quirks and properties which make them popular for investors.
If you’re looking at investing in cryptocurrencies, make sure you do your research to find ones that are more likely to give you a good return.
5. What Is a Wallet?
Since cryptocurrencies have no physical form, so you won’t need a real wallet. You do, however, need a digital one.
A digital wallet stores the mathematical keys that you need to use your cryptocurrency. Desktop wallets allow you to make use of your cryptocurrency from your computer. Mobile wallets are more useful, as you can use your phone to make physical transactions as you would with other NFC payment methods.
And there are also hardware wallets that you can plug into a USB port when you want to make a transaction.
6. What Is an Exchange?
A cryptocurrency exchange is a digital marketplace where cryptocurrencies can be bought, sold, or exchanged.
Exchanges match buyers with sellers just as with traditional currency exchanges. And if you’re new to cryptocurrency, the good news is that you can use traditional currencies in the exchange too, as well as trading between different forms of cryptocurrency.
Just as people make money buying and selling foreign currency, the same can be done with cryptocurrency.
7. What Are ICOs?
The number of cryptocurrencies is getting larger every day, thanks to ICOs.
In an IPO, a company issues stock to the public in order to raise capital. An ICO, or Initial Coin Offering, works in the same way, but the company offers cryptocurrency to the market instead of stock. Investors are hoping that the cryptocurrency issued will become the next big thing and give them huge returns.
Although this has been a shrewd investment in some instances, such as Ethereum, the sheer number of ICOs that are taking place these days means that there are far more losers than winners.
8. How Easy Is Investing in Cryptocurrencies?
Investing in cryptocurrencies is incredibly simple. Sign up to an exchange, and you can purchase cryptocurrency to your heart’s content.
You could then sit on your investment and hope that it grows in value. Or you could decide that you want to trade cryptocurrencies to try to make money from fluctuations in the market. You can even set up a crypto trading bot, which will make trades for you following a specific set of rules. This beauty of trading bots is that, if they are successful, you can actually make money while you sleep.
9. What Are the Risks?
The most obvious risk involved with cryptocurrency is that it is incredibly volatile.
At the end of 2017, the market cap of Bitcoin was over $230 billion. Sixth months later, it was just over $100 billion. The value of Bitcoin had more than halved. If you buy at the wrong time, you would have lost half of your investment in six months.
But the flipside of volatility is that the growth can also be huge.
10. What Are the Tax Implications?
Since 2014, the IRS has classified cryptocurrency as property for federal tax purposes.
This means that, if the cryptocurrency is held for more than 12 months, any gains made through the sale are taxed at 15% or 20% dependent on income. Under 12 months, it is taxed in the same way as any other capital asset.
You must make sure you keep detailed records of all transactions for the IRS.
Should You Invest?
Investing in cryptocurrencies is not a get rich quick scheme. You can just as easily lose a fortune as make one if you don’t invest sensibly.
If you are patient, do your research and only invest what you know you can afford to lose, then you can make money at it. If you’re interested in investing, check out some of our great content to help you learn more about your options.