You’ve probably heard of Bitcoin. After all, it’s the most recent craze in the investing world and has continued to be the most popular cryptocurrency available since the Bitcoin network came into existence on January 3, 2009.
However, a lot can happen in 10 years. The individual price of bitcoin reached a height of $20,000 in December 2017 — up from a value of basically nothing when they were created in 2009 — only to level out at around $4,000 per bitcoin in February 2019.
Although there may have been a “crash” in the Bitcoin market, that has not caused investors to lose interest in cryptocurrency. In fact, since its debut in January 2009, several other cryptocurrencies have come into existence, among them Ripple, Ethereum, and Litecoin.
With so much buzz around cryptocurrency — and the astronomical rise in the value of Bitcoin and other cryptocurrencies — you might be tempted to go all in.
But before you invest your money in any asset class, you should have at least a basic understanding of where that money is going. With more traditional investments like stocks on the stock market, it’s easier to wrap your head around the concept that your money is being used to buy part of a company, and when that company makes a profit, you share that profit when the price of your stock goes up.
However, when it comes to investing in cryptocurrencies, things are not so straightforward. In this beginner’s guide we’ll explain how to invest in cryptocurrency and a few key terms you should be familiar with before you decide to incorporate crypto investing into your personal investment strategy.
What Is Cryptocurrency?
First of all, let’s break down the word into its two parts: crypto and currency.
Before we go any further, it’s important to understand what a currency is. In basic terms, a currency is a sort of economic buffer that allows people to convert their skills and services into something that holds value, and can be traded for other goods and services. With paper currency such as the U.S. dollar, that economic buffer comes in the shape of a physical bill.
Next, the term “crypto” has to do with cryptography — which, according to the multinational cybersecurity company Kaspersky, is defined as: “the study of secure communications techniques that allow only the sender and intended recipient of a message to view its contents.” In other words, cryptography is about ensuring three key components:
- Confidentiality: The information cannot be understood by just anyone.
- Integrity: The information cannot be altered.
- Authentication: The sender and receiver of information confirm its accuracy.
As such, it should come as no surprise that cryptocurrencies are a digital currency, and rely on encryption to make transactions secure. Put more simply, cryptocurrency is a secure payment alternative to cash, credit cards, or checks that allows you to send payment directly to others without having to go through a third party financial institution, such as a bank.
How Does Cryptocurrency Work?
When you exchange cryptocurrencies for goods and services, it serves essentially as a virtual accounting system. But how does it work?
Bitcoin and other cryptocurrencies work using what is known as “blockchain technology.” The blockchain is a public ledger that records and stores all transactions using a certain cryptocurrency. Basically, every time someone buys something with a cryptocurrency, the information surrounding that transaction — e.g. the day, time, and amount — is recorded as a “block” which is then stored unalterably in an online database, or a “chain.”
If that seems a bit abstract, let’s use an example.
Let’s say Alex in the United States wants to send money to Rachel in Russia at 9:00 a.m. Central Standard Time on a Thursday morning. However, he doesn’t want to go through traditional financial institutions, and rather opts to pay her in bitcoin.
If Alex had decided to send Rachel U.S. dollars, a bank or credit card company would have to verify the accuracy of the transaction. However, because he performed the transaction using bitcoin, a network of computers on the blockchain rushed to check that his transaction happened the way he says it did — at 9:00 a.m. on Thursday.
However, for the network to confirm the purchase, time, amount, and participants, and add the transaction to the blockchain — or public ledger — it must solve a complex mathematical problem, known as a “hash.”
On average, it takes computers — and even supercomputers — an average of 10 minutes to solve a “hash.” While there are multiple computers on the network working to solve the hash, it is only the first computer that will be able to store the newly made transaction as a block on the blockchain — where it becomes unalterable. As a reward for performing the service, the computer receives a bitcoin.
How Do You Invest in Cryptocurrencies?
Now that you have a basic understanding of what cryptocurrencies are and how they’re created, you might be interested in investing in them as an asset class. If so, there are a few things you’ll need to get started:
1. Digital Wallet
Before you can even start thinking about buying cryptocurrency, you’ll need to have somewhere to store it. Somewhat like a traditional bank account where you store your dollars, you’ll need to set up a digital wallet — also known as a hardware wallet. It’s a program you’ll need to store and transact with your cryptocurrency.
As with an online bank account, there are specific identifiers to make sure you are the only one who has access. Rather than a bank account number and routing code, you’ll use two unique cryptographic keys: a public key and a private key.
Your public key is the identifier you’ll use to signal where transactions should be deposited to and withdrawn from, and will also appear on the blockchain ledger as your digital signature, similar to how banks use your account number. The private key, on the other hand, is like a password that is required every time you want to buy, sell, or trade with funds from your cryptocurrency wallet.
2. Personal Identification
Just as when opening a more traditional bank account, the U.S. Securities and Exchange Commission also requires individuals to verify their identities before registering for a digital wallet. As a result, in order to buy or sell any cryptocurrency, you’ll need to verify your identity with the usual documents — a driver’s license and your Social Security number.
3. Bank Account
Speaking of bank accounts, you’ll need to connect one to your digital wallet if you hope to exchange your U.S. dollars for cryptocurrency. However, if you’d rather not connect a bank account, you also have the option of connecting a debit card or credit card for purchasing purposes.
While you might be able to open a bank account or brokerage account in more of an analog way — over the phone or in person — with cryptocurrency you can only transact digitally. You’ll need a secure internet connection since you’re planning to buy or sell currency. Do not invest in cryptocurrency using the public Wi-Fi at your favorite coffee shop.
5. Pick a Cryptocurrency Exchange
Finally, you’re getting to the crux of it. Once you’ve created your digital wallet and connected it to a payment source — on a secure internet connection — you can now actually start thinking about investing in cryptocurrency. The last step is to decide on an “exchange.”
These exchanges are basically online marketplaces, and are similar to trading platforms where traditional stock traders buy and sell stock. An exchange will connect you directly to a marketplace where you can trade the traditional currency in your bank account for cryptocurrency.
Now, there are various exchanges available. Which type of cryptocurrency you choose to invest in — some of the most common are Bitcoin, Ripple, Litecoin, and Ethereum — will help inform which you should choose. As a starting point, some of the most commonly used are Binance, Coinbase, and SquareCash. Once you pick the one that’s right for you, you’re now ready to put your cryptocurrency investing strategy into action.
Is Cryptocurrency Investing Right for You?
Cryptocurrencies are still new and largely misunderstood. However, some financial experts believe that they will become the most important asset class of our time. On the other hand, giants in the investing world — including Warren Buffet — have expressed a distaste for the cryptocurrency market, claiming it is purely for gamblers and speculators.
Whether you agree with the former or the latter, there’s no arguing that cryptocurrencies are an investment opportunity that well-informed investors should at least be aware of, even if comprehension of the exact mechanics behind cryptocurrency lags a bit behind.
That said, if all the talk about blockchains and hashing seems like gibberish to you, you may want to examine whether cryptocurrency is the best opportunity. After all, the best investments are those that you can manage with confidence — and confidence requires understanding. You might also consider holding off if you don’t have ample savings, you’re in significant debt, or behind on your retirement savings goals.
On the other hand, if you’re on track financially, looking into cryptocurrencies — including penny cryptocurrencies — might be worthwhile. Be willing to do the research necessary to ensure you can make informed decisions about how to buy, sell, and invest in cryptocurrencies as a digital asset, and how that asset can help to grow your net worth — then you’ll be prepared to jump right in and start investing.