Cryptocurrencies have attracted millions of traders, investors, and consumers over the past 15 years. After initially attracting libertarians seeking independence from conventional finance, the industry's massive growth drew investors and traders into the fold. And these days, billions of dollars of venture capital are pouring into the industry.
Let's take a look at how beginners can dip their toes into cryptocurrencies without having to know how bridges work or the nuances of dApps.
The crypto market has evolved from Bitcoin in 2007 to over 20,500 coins across more than 500 exchanges – here's how beginners should approach the market in 2022.
What is Cryptocurrency?
Most people have heard of cryptocurrencies but may not know how they work or how they differ from something like a debit card.
A cryptocurrency is a digital or virtual currency that uses cryptography to secure transactions. Unlike the fiat currencies that central banks issue, cryptocurrencies don't have any central issuing or regulating authority. Instead, they use a decentralized peer-to-peer system to record transactions and issue new units into digital wallets.
Cryptocurrencies derive their name from the cryptographic techniques they use to verify transactions. At their core, cryptocurrencies are simply entries on a digital ledger known as a blockchain. Anyone can create cryptocurrency units by solving mathematical puzzles or staking their crypto to verify and add transactions to the blockchain.
Many people like cryptocurrencies because they are decentralized, pseudo-anonymous, and not inflationary. In addition, the energy or staking requirements make it nearly impossible for someone to add counterfeit transactions, making it a safe store of value. Many new and exciting products and services are also built atop cryptocurrency.
Why Invest in Crypto?
Satoshi Nakamoto originally built Bitcoin as a virtual currency that cut out financial intermediaries, such as banks or payment processors. Since then, Ethereum and other projects have built upon these foundations to power everything from decentralized finance (DeFi) lending protocols to non-fungible tokens (NFTs) representing in-game items.
There are many reasons to invest in these different assets:
- Bitcoin investors hope the digital currency will become even more popular as the supply dwindles from mining activity. With a 40% share of the crypto market, it’s the largest, oldest, and most popular cryptocurrency in existence.
- Ethereum investors hope that dApp developers will continue developing cutting-edge use cases for altcoins, increasing their value over time as a transaction unit. With a 20% share of the market, it’s the basis for many other tokens and a transactional standard.
- Utility coins may have their own ecosystems that create value, powering everything from gaming to cross-border payments. For instance, Ripple enables anyone to send international payments at a much lower cost than the competition.
- NFT collectors hope that the digital art or other asset underlying their NFT will increase in value. For example, Bored Apes Yacht Club NFTs have a floor price of around $140,000, making them extremely valuable as collectibles.
- DeFi participants earn interest or rewards from lending their cryptocurrencies or providing liquidity to exchanges. While these yields are coming down to earth, they still may be a compelling alternative to conventional bonds or dividend stocks.
Before diving into initial coin offerings (ICOs) or DeFi protocols, beginners may want to start by investing in the "blue chip stocks" of the cryptocurrency world. Bitcoin is the largest cryptocurrency, with a market capitalization of nearly a half trillion U.S. dollars. Meanwhile, buying Ethereum is the gateway to participating in DeFi or buying NFTs.
Finally, it's worth noting that cryptocurrencies are risky investments, given their notorious volatility, propensity for fraud, and lack of regulations. In addition, there's no central entity capable of reversing fraudulent transactions or recovering funds in the event of a data breach. As a result, you should assess your risk tolerance and diversify to reduce risk.
How to Get Started
The easiest way to invest in cryptocurrencies is through a centralized exchange (CEX) like Coinbase. Anyone can use Coinbase's mobile app to deposit fiat currency, such as U.S. dollars, and purchase Bitcoin, Ethereum, or other cryptocurrencies. These are held in an account the same way Robinhood or other brokers hold a stock.
The next step is deciding which cryptocurrency to purchase and when. Many long-term investors periodically buy cryptocurrencies to dollar-cost average over time, whereas short-term traders may use technical analysis to identify optimal entry and exit points. The best strategy depends on your individual goals, expertise, and risk tolerance.
If investors are comfortable, they can use their cryptocurrencies to lend in DeFi protocols and generate income or invest in NFT assets. The most reputable DeFi protocols include Curve, Uniswap, and Aave, although hacks and other issues have affected projects of all sizes in the past. And OpenSea is the most common place to purchase NFTs using Ethereum.
Investors seeking exposure to cryptocurrencies without purchasing them may also want to consider exchange-traded funds (ETFs). For example, the ProShares Bitcoin Strategy ETF, Valkyrie Bitcoin Strategy ETF, and VanEck Bitcoin Strategy ETF all offer exposure to Bitcoin through a conventional ETF that you can purchase in a brokerage account.
Finally, the IRS considers cryptocurrencies property, subjecting them to capital gains taxes. So if you trade cryptocurrencies, it's a good idea to use a tool like ZenLedger (free for small accounts) to track your trades across exchanges and compute your year-end capital gain or loss. Otherwise, you may have to reconcile these transactions manually!
The Bottom Line
Cryptocurrencies are a unique asset class for every trader or investor to consider. While they can be a challenge to understand fully, centralized exchanges like Coinbase make it easy to get started. After dabbling in Bitcoin and Ethereum, more experienced investors can move on to leverage DeFi to create income or speculate on NFTs or ICOs.
At ZenLedger, we've built the most comprehensive and easy-to-use platform to handle crypto taxes. We have integrations with almost every major exchange and wallet, along with DeFi protocols and other services. In addition, our platform integrates with TurboTax to automate tax filings or populates IRS forms that you can provide to your accountant.