There are different ways to profit from cryptocurrencies and the best investment vehicle will depend on your specific financial goals. Get started by following the steps below:
Determine which cryptocurrencies you want to invest in and how much you are prepared to risk.
Determine a maximum time frame for cashing out the investment, and targets for cashing out that will be acted upon if they are reached before the maximum time frame. The length of the maximum time frame is a personal decision, but something between 9 months to 2 years is probably optimal. You can always decide to invest again when the time is up. Deciding the targets at which you will take profit before the time limit is up is also a personal decision, but as a rule, it should be at least 300%. This is because targets should be exponentially greater than risk, and the risk is effectively 100%. Additionally, we have seen price rises in cryptocurrencies by this amount or more within the past 6 to 9 months or so, and it makes sense to have targets that match prevailing conditions of volatility.
Determine how you will invest: whether by direct ownership, or indirectly by purchasing shares in a cryptocurrency fund. By late 2017, a third option should exist- the possibility to buy options on the major cryptocurrencies. Remember that if you want to be involved in the smaller cryptocurrencies, you will probably have no alternative except buying them directly, as few funds offering shares will be investing in them.
Direct Purchase of Cryptocurrencies
For most investors today, the cheapest method once transaction fees are considered, is simply to buy cryptocurrency directly and store it. This leaves you, the investor, with the legal ownership of the asset as well as the responsibility of storing and protecting it. The worry is in protecting the code, as the proof of ownership of most cryptocurrencies is like a bearer share: anyone with access to the code can “spend” the cryptocurrency. Remember that even if you have the code on a piece of paper, and receive and store it by email, it is just as vulnerable to hacking as your email is. An alternative storage and protection method is to use a digital wallet and/or vault. These can be a third party’s server, a smartphone app, or a program you store on your computer or on a flash drive. You can download them all for free. All these methods have obvious advantages and potential risks. There is always some risk of hacking or physical damage resulting in a total loss of the investment.
As for making the actual purchase, there are two main methods:
Using an online cryptocurrency exchange, such as Coinbase. They typically charge fees of at least 5% of the transaction value.
There are ATMs in some cities which accept cash, debit and credit cards in exchange for cryptocurrency. A fee of up to 18% will be charged on a transaction, and you must have a wallet set up before you can make the purchase. Many ATMs offer only Bitcoin, but some can also be used to buy Ethereum, Litecoin, Dash, and Dogecoin.
Don’t forget that ATMs only allow the purchase of cryptocurrencies, and not sales. This means that if you own cryptocurrency and want to cash in your investment later, you will have to open an account with a cryptocurrency exchange to make the sale. Of course, at some point in the future, there may be a wider range of ways to spend cryptocurrencies or otherwise cash them in, so your options are likely to be better than they are now.
Although the cheapest possible method of direct purchase is usually through online exchanges, it can take a while to open an account and fund it, by providing ID and other required proofs, and making the bank or credit card transfer. It is also true that many exchanges do not yet accept deposits from residents in many countries. This means that if your country has an ATM where cryptocurrency can be purchased, this may be your only option, even though the fees are higher.
The usual method is as follows:
download a wallet application onto your smartphone which can store your desired currency.
Obtain the amount of cash you wish to invest. At the ATM, select your purchase and feed in the required cash. The ATM then allows you to scan your smartphone, and deposits your cryptocurrency into your smartphone’s wallet. You now have the proof of ownership stored in your phone.
The wallet may not show you the cryptocurrency’s current value in the fiat national currency you want to value your investment in, so you will need to make a note of the price at which you made the purchase and judge its fluctuations from there.
For this reason alone, online exchanges are easier to operate and monitor, and they can be funded by bank transfer, credit cards and other methods instead of cash.
Another option which might be useful if you want to be highly diversified and invest in a range of different cryptocurrencies, is to buy shares in a cryptocurrency fund. The fund will buy and sell substantial amounts of cryptocurrencies, according either to fixed rules which are known to you, or to its own discretionary and active management. You buy a share of the fund, hoping that at some point in the future, the fund’s investments will have increased in value, and you will be able to sell your shares at a profit.
An example of a fund with fixed rules would be a fund that works as an index tracker. Imagine a fund that aims to track the performance of a major stock index like the S&P 500, which is composed of the 500 largest publicly quoted companies in the U.S.A. in terms of market capitalization, in weights in proportion to the capitalization sizes. In the same way, a fund might exist that invests in the 10 largest cryptocurrencies, periodically rebalancing as capitalizations fluctuate and as new cryptocurrencies occasionally replace older ones within the top 10. You might be interested in buying shares in one of these “tracker” funds. Other funds might offer a more discretionary and active investment style, choosing to invest or even trade the larger cryptocurrencies actively. Others still will specialize in long-term investments in small cryptocurrencies, where they expect to see long-term growth. Generally, cryptocurrency funds will be “long only”, and are an emerging area, where we can expect to see more choice as time goes by.
The major advantage of investing in cryptocurrency funds is that is offers an easy and sophisticated service. However, there is often a serious drawback in these funds: they usually trade at a high premium above the net asset value, or in plain English, are seriously overvalued beyond the assets they own. This means that unless you are getting active investment management or a very accurate tracker of the entire market, you are likely to have to pay much more than you should for the shares, making it an uneconomical option. Things may improve in the future as the market matures.
An alternative method for building something similar to a Fund approach is to use the broker eToro, which at the time of writing offers a “CryptoCurrencies Copy-Fund”. Buying or selling units in the Fund allows the trader to automatically copy eToro’s top traders’ operations in Bitcoin and Ethereum, weighted according to the currencies’ respective market capitalization.
Cryptocurrency Options & Futures
Options and futures are derivatives contracts which allow the investor or trader the chance to profit exponentially when they are right, while limiting their potential loss when they are wrong to a defined and relatively small amount. At the time of writing, there are a few online exchanges which offer such instruments based upon Bitcoin; however, deposits must be made in Bitcoin itself. This is expected to begin to change by the end of 2017, but for now, here is an example of how such an investment could work:
You believe that the price of Bitcoin will rise strongly over the coming weeks, and three months from now will be valued well over $6000.00 per coin. Say it is presently valued at $4000.00 per coin. You are prepared to risk $800 on this transaction. You could simply buy $8800 worth of Bitcoin, or you could buy the Bitcoin and deposit it with a Bitcoin options & futures exchange and buy an option for $800.
If you buy $500 of Bitcoin, and after three months the price has risen from $4000.00 to $6000.00, you could sell your one eighth of a Bitcoin for $750, collecting a profit of 50% ($250).
Alternatively, say you buy an option to purchase Bitcoin at $4000 per coin in three months. The price of the option is $800, and after three months, the price of Bitcoin has risen from $4000 to $6000. As the option gives the right to buy 1 Bitcoin at a $2000 discount, it will be worth (just under) $2000, generating a profit of $1,200 ($2000 minus the purchase price of $800), equal to a return of 150% (ignoring any financing costs).
Such an option would expire worthless if the market price is less than $4000, and would produce a net loss if the market price is less than $4800 (the cost of the option plus the exercise price).
Futures contracts are a little different: instead of giving you an option to buy or sell at a particular price at a future date, they are a commitment to do so. The logic of profit and loss is effectively the same as outlined above for options trading.
At the end of 2017, the Chicago Board of Exchange hopes to begin offering futures in Bitcoin, which could be purchased directly with fiat currency, and may expand later to other, larger cryptocurrencies, and to options as well as futures.
It should be noted that online cryptocurrency exchanges are currently only offering options and futures in Bitcoin. As these options and futures can be bought and sold on a secondary market within the exchanges and do not have to be held until maturity, they can also be a suitable vehicle for anyone wishing to trade Bitcoin instead of investing. Trading cryptocurrency is covered in the next section of this guide.
Key point for investors: many investors lose money because they hold onto their investment too long and fail to take profits in a timely way. Another common mistake is getting too excited by floating profit (profit on the table) and cashing out too early, when the best thing to do is sit tight. As mentioned earlier, the best chance to avoid these mistakes is to decide a future date when you will cash out no matter what, and to make sure you cash out in advance if your investment reaches a certain return, which should be at least 300%. If your investment is rising strongly when it reaches the profit target, it may be wise to wait until it stops rising – using this technique, you have a good chance of picking up some extra profit.