Investing in cryptocurrency has long been a divisive topic. An emerging asset class, crypto can see dramatic price moves, making it a risky but potentially rewarding option for investors to add to their portfolio. Before you consider investing in cryptoassets, it’s important that you first learn what they are and why they might be a good investment opportunity. Discover the risks of cryptocurrency trading and whether you should believe some of the common myths about crypto.
Cryptocurrencies: how to invest in a volatile asset class
Cryptocurrencies and other cryptoassets are known for their dramatic price swings, which won’t always go the way that you hope for. However, this volatility has historically worked in some investors’ favour, making it an asset class that shouldn’t be ignored.
Tip: The anonymous and decentralised nature of cryptocurrency means that it operates independently of governments and central banks and is viewed as an alternative to traditional fiat currencies.
What are cryptoassets?
Cryptoassets are digital assets stored on a blockchain. Cryptoasset transactions are encrypted using cryptography and serve as a potential alternative to government-backed fiat currencies. Traditionally, cryptoassets are considered to be decentralised, meaning they are controlled by a network of users, rather than a single point of authority.
The cryptoasset sector is still in a period of relative infancy, with bitcoin, the cryptocurrency that helped to popularise the asset class, only launching in 2009. The industry has expanded in recent years, with new cryptocurrencies being launched regularly and decentralised finance (DeFi) continuing to branch out significantly. Although most often used to describe cryptocurrencies, the term “cryptoasset” can also be used to refer to non-fungible tokens (NFTs) , utility tokens, stablecoins and more.
Tip: From the perspective of an investor, it’s important to remember that the value of cryptoassets is determined by the fundamental price drivers of any market — supply and demand.
Why should you be investing in cryptocurrency?
The price volatility of cryptocurrencies makes them an interesting proposition for investors. It is possible, as with any asset, to make or lose significant amounts of money, although this process can be exacerbated within crypto. Price swings are often driven by conversations about the revolutionary nature of cryptocurrencies, as well as by wider economic factors.
Some investors buy crypto because they believe it will receive more mainstream acceptance and adoption in the future. Bitcoin (BTC) was launched in 2009 as a response to the financial crisis and amid concerns about the reliability of the mainstream banking sector.
Since then, cryptocurrencies have been bought by those interested in protecting their capital from the devaluation of fiat currencies, political instability and third-party involvement in their finances. Others take a more speculative approach, and trade crypto to try and take advantage of its price movements.
Regardless of your reasoning, it’s important to try and understand the technology behind cryptoassets, as well as the potential benefits and risks that diversifying your portfolio with cryptocurrencies can bring.
In the case of crypto, the risk-return level is significantly higher than it is on other asset classes. This doesn’t make it a bad investment… but it does make thorough research more important than ever.
Common crypto myths
The adoption of any new technology comes with potential pitfalls, and previous events and developments have changed the way that investors perceive cryptoassets, often for the worse.
As witnessed by other areas of the financial markets, there have been instances of fraud and malicious attacks within crypto. However, these reports often focus on the negative aspects of the asset class, rather than adopting a realistic view of the crypto markets as a whole.
Consider some of the myths surrounding crypto and whether they accurately depict the current state of the sector.
|Crypto isn’t secure
|Although largely unregulated, blockchain technology — including cryptography — makes cryptoassets incredibly secure, as long as precautions are made when users complete transactions.
|Crypto is used for illicit activity
|The anonymity attached to crypto helps to make them more decentralised, but unlike cash, all crypto transactions are recorded and stored on the blockchain.
|Crypto doesn’t have value
|Because of DeFi protocols, such as smart contracts and other decentralised applications (dApps), cryptoassets can potentially revolutionise the financial system.
|Crypto is bad for the environment
|Some cryptocurrencies utilise a Proof of Work (PoW) protocol, which has a high energy usage. More recently, more energy-efficient alternatives, such as Proof of Stake (PoS), are being used.
|Crypto is a scam
|There have been cases of fraud, so investors should carry out due diligence before investing in crypto, as they would with any asset class.
Tip: Cryptoassets are very different from mainstream financial assets. This could make them a good option for investors looking to diversify their portfolio, although be sure to research any potential investments before committing capital to a trade.
How to start investing in crypto
To start investing in crypto, investors must first create an account with a broker. Brokers have online trading platforms that enable investors to buy and sell crypto 24/7.
It’s important to develop a wider investment plan before committing real funds to a trade. Also, ensure that you thoroughly research your chosen cryptoasset before investing. Given the volatile nature of the crypto markets, it’s crucial that investors only commit capital to cryptocurrency positions that they are willing to lose if the value of the asset was to fall significantly.
The risks of cryptocurrency
All assets are vulnerable to market risk, but cryptocurrency investors should be aware of how extreme price movements can be with this asset class in particular. Markets have been known to move over 10% in a matter of minutes, which could potentially lead to emotional investing.
The Fear and Greed Index is usually a good indicator of investor sentiment, but crypto markets have been known to rise or fall based on a number of geopolitical or wider economic factors, as well as industry-specific news. Investors should be wary of crypto price volatility, but if timed correctly, it could create an opportunity for a positive return on investment.
Tip: Operational risk, the chance that your broker or platform is a scam or goes bust, applies to all assets, but has historically been higher than average in the crypto sector. Using a trusted and secure trading platform should negate some of this risk.
Investing in any asset, such as stocks or bonds, involves assessing its risk-return. In the case of crypto, the risk-return level is significantly higher than it is with other asset classes. This doesn’t make it a bad investment, especially because of the potential that crypto investments can have, but it does make thorough research more important than ever.
- Can I use leverage when trading crypto?
Leverage may be available when trading crypto, although this will ultimately depend on where you live. Some regulators, such as the FCA, have banned the use of CFDs and leverage when trading crypto, while other regulators are currently working on similar controls.
- What happens to my crypto if my broker goes bust?
This will depend on the exact T&Cs of your agreement with your broker. Some brokers will hold cryptoassets in segregated accounts, so that if the firm goes bust, investors’ interests are protected. Cryptoassets are unregulated, so there is less protection available to them as an asset group, compared to stocks and bonds, for example.
- Do you need a strong risk appetite to invest in crypto?
There is room for cryptoassets in all investors’ portfolios. Fans of crypto, who allocate their capital to cryptocurrencies and other digital assets, will likely experience considerable price moves and a wide range of emotions. Alternatively, smaller positions in cryptoassets are a justifiable part of a diversified portfolio. Regardless of your risk appetite, make sure to only invest what you can afford to lose.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments. This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past performance of a financial instrument, index or a packaged investment product are not, and should not be taken as a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.