Cryptocurrencies in the crypto industry have become popular among many different groups of people. Enthusiasts believe that it could eventually replace fiat currency, active traders are drawn to the volatility, and institutional investors are interested in the diversification benefits. While each strategy is different, there are some commonalities between them.
Let's take a look at three ways that can help you figure out how to make money with cryptocurrency and how to decide on the right option for you.
How To Make Money With Cryptocurrencies - 5 Ways To Make Crypto Money
Here's what you need to know to earn money:
#1. The Buy-and-Hold (HODL) Crypto Investor
Many cryptocurrency enthusiasts believe that digital currencies could replace fiat currencies over the long term, creating significant value for early adopters. For example, the combination of rising demand and a limited supply of Bitcoin could translate to rising prices over time. The million-dollar question is if and when the transition will occur.
On the other hand, many altcoins aim to create value by building digital assets ecosystems. Ethereum's dApps are a perfect example of how cryptocurrencies could appreciate over time by becoming an important medium of exchange. The success of these cryptocurrencies depends largely on the platform's adoption rates and demand in the marketplace.
Buy-and-hold investors can make money by identifying and investing in the best long-term cryptocurrency opportunities — whether that's Bitcoin mining or altcoins.
#2. The Active Crypto Trader
There's no doubt that cryptocurrencies are volatile assets — it's not uncommon for them to rise or fall by double-digit percentages in a given day or week. Then, how to make money with cryptocurrency?
These crypto trader dynamics make the digital currencies attractive to active traders that aim to capitalize on short-term price movements. For example, they may buy and sell a cryptocurrency within just a few hours.
Most active traders use technical analysis to analyze prices and find important trends. Technical indicators synthesize prices into understandable statistics to predict overbought or oversold levels, while chart patterns can help provide insight into underlying market psychology. The combination of these analyses can generate buy and sell signals.
Risk management is equally important to ensure long-term success. Rather than making big directional bets, the best way to make money is by using these successful active traders who focus on making small profits with minimal risk. They may develop and backtest a day trading system with a projected win/loss rate and ensure that position sizes are optimized to prevent any significant drawdowns.
#3. The Diversified Crypto Investor
Cryptocurrencies are relatively uncorrelated with conventional financial assets, such as stocks or bonds, which makes them valuable on an institutional level. By improving the diversification of a portfolio, cryptocurrency assets can improve long-term risk-adjusted returns — even if they aren't always the best-performing asset in the portfolio.
For example, an investor that held an all-stock portfolio between January 2008 and the market bottom in February 2009 would have lost about 50% of their capital. A diversified investor with 50% domestic stocks, 20% international stocks, and 25% bonds would have only lost 35%. More importantly, the two portfolios performed roughly the same by February 2014.
Investors looking to improve diversification may use conventional financial assets rather than purchasing cryptocurrencies directly. While there aren't any U.S. ETFs at the moment, international investors can purchase U.K. ETNs and U.S. investors can participate in the Bitcoin futures market, making it possible to diversify without owning cryptocurrency.
Crypto mining is among the first few ways to earn money using cryptocurrency. Mining is used in blockchains that run on a proof-of-work (PoW) mechanism. Miners use specialized computer hardware to solve intricate mathematical puzzles to verify transactions and add blocks on the blockchain. For their effort of validating transactions and adding blocks on the blockchain, they are rewarded with freshly minted coins. However, it is important to note that to mine cryptocurrency, you have to make an upfront investment in specialized computer hardware.
Unlike mining, staking doesn’t require advanced computer hardware. Staking works for blockchains that use the proof-of-stake (PoS) consensus mechanism. In staking you have to stake or lock your coins in a crypto wallet. After that, you have to validate crypto transactions and earn rewards in return. In short, you are lending your coins to the network to maintain its security.
The reward for staking is just like earning interest from a bank for your funds in the account. One more thing to note is that the PoS algorithm chooses validators to verify transactions based on the number of coins staked. So, the more coins you stake the higher the chance of being chosen as a validator.
What Kind of Crypto Trader Are You?
There are many different ways to make money with cryptocurrency, but the right decision for you depends on your investment objectives and risk tolerance. For example, someone living on a fixed income in retirement with little disposable income should avoid risky speculation, but could benefit from added diversification for their portfolio.
It's also important to keep in mind that cryptocurrencies differ from other financial assets. In particular, most conventional financial assets generate cash flow over time. Cryptocurrencies should be thought of as an alternative to precious metals like gold, which don’t generate any cash flow and may be used to hedge or speculate.
Tips to Keep in Mind
Traders and investors should understand the tax implications of each strategy. Since the IRS treats digital currencies as property, they are taxed in the same way as conventional stocks and bonds. Long-term investments are taxed at lower capital gains rates than short-term investments held for less than a year. Higher turnover leads to higher tax and transaction costs.
The IRS tax rules require all traders and investors to pay capital gains tax on sales, which involves calculating the cost basis and recording each transaction. ZenLedger simplifies the process of aggregating transactions, calculating the cost basis, and completing Form 1040 Schedule D, Form 8949, and other IRS tax forms that are required for crypto transactions.
In addition to tax considerations, traders and investors should carefully choose crypto exchanges. It's important to consider transaction fees and spreads, cryptocurrency liquidity, research and analysis tools, insurance, and other factors. Coinbase Pro is a popular option that provides fair pricing, transparent operations, and insurance against loss.
How To Successfully Trade Cryptocurrency Webinar
ZenLedger COO Dan Hannum, recently interviewed crypto advisor and advocate, Scott Melker, aka The Wolf Of All Streets, about trading crypto. Scott is a trader and investor, the host of the popular “Wolf of All Streets Podcast,” and a prolific writer and thought leader in the crypto space. He shares his vast crypto trading knowledge including how to choose a trading strategy, how to decide what to invest in, and trading tips and mistakes to avoid during our how to successfully trade cryptocurrency webinar.
The Bottom Line: Understanding The Ways To Make Money Using These Coins For Profit
Cryptocurrencies have become an important asset class for a variety of different traders and investors. Whether you're a crypto enthusiast, long-term investor, or short-term trader, there are opportunities to make money from the attributes and behaviors of cryptocurrencies in the market. The key is knowing where you stand and using the right forms of analysis.
Read also - Crypto Cost Basis Calculator: All You Need To Know About Tracking Cost Basis Across Wallets And Exchange
If you're interested in simplifying your taxes, try ZenLedger's cryptocurrency tax solution to automatically aggregate transactions, calculate cost basis, and pre-fill the IRS forms that you need to remain compliant with the IRS.