Everyone has an opinion on crypto and digital currencies. Some say there’s no future in it, others declare it is the future. Regulators warn against it. Yet governments want to create their own. So, what’s the right answer? And should you invest in cryptocurrency to grow or preserve your wealth? The truth is that there is no one-size-fits-all approach. What works best for you will depend on your unique situation. If you’re thinking of buying your first coins, here are three big questions to ask yourself.
Is crypto a good match for your financial situation?
Before diving in, take a step back to examine your finances. Really look closely. And consider these important points:
· Never invest if you can’t afford it
Think carefully about upcoming payments or bills like rent before you take the plunge. It’s better to have a place to live and food to eat than a fistful of investments!
· Pay off “bad” debt first
If you’re lugging around “bad debt” like credit card repayments or pay-day loans, sort those out first. This is because the interest is likely to be higher than the profit you could make from investing.
· Get an emergency fund
Experts recommend having three to six months’ worth of savings tucked away for a rainy day. This means if you unexpectedly lose your income or have a sudden expense you won’t be caught out.
· Build a savings pot
Investing is for the long-term, meaning at least five years. So if you’re planning to spend your money in the near future, it could be better to put it in a savings account. You’re unlikely to make much profit, but the risk of losing it is almost zero.
Simply put, financial wellness is crucial. Before you start buying your first coins, make sure you’ve checked all these boxes. Affordability, debt management, emergency funds and saving pots are the foundations of good investing.
Do you understand cryptocurrency?
The best investors know assets inside-out. That’s why it pays to make sure you understand what you’re getting into before you make any financial decisions.
· How cryptocurrency networks work
As a 101 starter, you could think of cryptocurrencies as a public, permissionless and computerised way of agreeing among ourselves who owns what (see this handy 2-minute explainer) - while eliminating the need for go-betweens and making it prohibitively expensive or resource-intensive to game the system.
· Decentralised assets
Unlike the banknotes and coins in our wallets (sometimes referred to as ‘fiat money’), cryptocurrency doesn’t have central banks and governments presiding over it. Depending on your political stance, that could be either good or bad.
On the one hand, anyone anywhere in the world can hold and send cryptocurrencies to anyone else without any intermediary or middleman, transacting cheaply, quickly and conveniently direct from a computer or mobile phone; on the other, you have to remember that cryptocurrencies can be extremely volatile and don’t come with the same consumer safeguards you get with traditional money. Self-education, personal responsibility and awareness of risk is the best defence.
· Scarcity models
While every coin is different, the most well known cryptocurrencies such as Bitcoin operate on a scarcity model. This means the amount of coins created is limited to a certain number. Once that number has been reached, no more will be made. This differs from traditional currency where money may be issued at will. In theory, this should mean that supply-capped cryptocurrencies perform well over time provided they can maintain and grow demand. However, due to the use of cryptocurrency as a speculative investment vehicle, you should be aware that this is subject to cycles of significant volatility, themselves linked to prevailing investor sentiment and the performance of the wider economy.
· 100% traceability
Cryptocurrency is unique as an investment in that it is 100% traceable. Thanks to blockchain technology (see our 101 guide here), every single transaction is publicly and permanently recorded. This provides a sense of assurance. If the coin belongs to you, it belongs to you (unforeseen technical failures excepted) until you sell it. But that doesn’t mean it's scam-free. Like all investment assets, it’s important to deal with trusted wallets and platforms. Double-check where you’re sending coins to and why and practice good basic security.
· Find the right coin for you
There are more than 19,000 types of cryptocurrency and crypto tokens circulating on the market, and the number is growing all the time. Each one has different characteristics, advantages and disadvantages, and it would take a whole other article to explore the categories and subcategories of cryptocurrencies, utility tokens, governance tokens, stablecoins and NFTs. Finding the right coin for you is an important part of the process, so make sure you do plenty of research before investing. The two most common are Bitcoin and Ethereum.
· Bitcoin and Ethereum currently dominate the market
Bitcoin is by far the most famous and popular coin, probably because it was the first! It’s well-established which is a great advantage. However, one of the criticisms is that it uses a lot of energy. Ethereum has quickly emerged as another mainstream favourite, and upcoming upgrades will slash energy consumption and develop the network. Some luxury fashion brands like Gucci are now accepting either of these mainstream coins as payment, along with multiple others.
Getting to grips with how cryptocurrency works will help you prepare for the road ahead, and figure out if it’s the right solution for you.
How do you feel about risk and volatility?
Generally speaking, cryptocurrency investors are hoping to make a profit, known as growth investing. But the journey can be a bumpy one!
· Stomaching risk and volatility
Cryptocurrency can be notoriously volatile. Its value could soar and plummet overnight. Depending on the type of person you are, you could find this nerve-wracking or exciting. That feeling is also known as your risk tolerance and it’s an important part of deciding if crypto investment is right for you. Think carefully about how you’d feel if your coins went on a rollercoaster, would you enjoy the ride or would your stomach lurch?
· Factors influencing the price
There are many theories as to what makes the value of crypto coins go up or down. Unlike traditional investments, we can’t use corporate balance sheets, price-to-earnings ratios or conventional valuation models as a guide (though crypto has and will undoubtedly continue to develop its own unique models over time).
Instead, adoption, use case and network effects play more of a role. Do you understand and value the problems the technology is aiming to solve? Do you see the evidence of use and adoption? Do you see the possibility for longer-term market appreciation based on the supply/demand mechanics (generally referred to as ‘tokenomics’)
Increasing monetary inflation also seems to have an effect. When existing currencies become perceived as less reliable and less valuable over time, investors tend to turn to other assets like gold, collectables or indeed bitcoin.
· Herd mentality
We also have to be honest that, outside of the most mainstream projects (and at least to some degree inside of them as well), valuations can be driven by little more than hype and social sentiment. Crypto is highly susceptible to a type of investing behaviour known as “herd mentality”. This means investors can react to each other - and the information spread by online ‘influencers’ - driving the price up or down quickly based on little more than common excitement. Investing in crypto means being aware of these cycles, learning to assess things for yourself and making your own informed decisions.
Taking the first step
Investing in cryptocurrency is a big step. Getting to grips with how it works, as well as understanding your risk tolerance and financial situation, is a must for new investors. If you’d like to find out more or get started, we’re here to help.