So you’ve been following cryptocurrencies for a while. You’ve seen Bitcoin explode in value, from tiny fractions of a cent a few years ago to their peak of over a thousand dollars. You are, understandably, interested in investing in them. If you’re going to take that road, you need to be aware of some very important details…
Cryptocurrencies (explained in full detail in our free eBook) are an enormously powerful idea. They’re a way for thousands of people all over the world to come together and agree on basic questions like “How much money does each of us have?” even when all of them have an incentive to try to trick one another. The practical upshot is that this is a way to create money without the need for a (potentially fallible) central authority. That said, despite the rising value of cryptocurrencies, many people have lost a lot of money on them.
So what are the most important things for you to know going into cryptocurrency investment?
Treat It As Speculating, Not Investing
Let’s be clear here: cryptocurrencies have a bright future as a powerful new way to conduct commerce. That is not the same thing as saying that their value right now is sustainable. It’s early days yet, and, while the number of businesses accepting cryptocurrencies is growing, it’s not big enough for most of the demand to be built on legitimate trade. That means that buying cryptocurrencies is speculation, not investment – unless you plan to spend them, or hoard them for decades until they becomes ubiquitous.
Right now, the price of cryptocurrencies is vulnerable to the whims of eager new speculators like you, and people who’ve been in the market for a while and are just looking for the right time to get out, which cause the market’s precipitous ups and downs. The result is that speculating on cryptocurrencies is something of a zero-sum game. That doesn’t mean that you can’t make money in the long term by being wilier than average, but it does mean that, at the end of the day, somebody else has to get stuck with the check.
So, be careful. Don’t put your life savings into it. Invest conservatively: try to keep half your investment money in cash at any given time, which leaves you in a good position to profit on the ups and downs of the market. If you wipe out your stake entirely more than once, and are tempted to put more back in, don’t. Day trading can be a form of gambling addiction, so be careful not to let it eat your life.
Be Paranoid About Security
Even more lucrative than investing in cryptocurrency is stealing it from someone else who wasn’t sufficiently careful about the security of their wallet. We’ve covered this topic before, but it’s worth reiterating the main points: use secure wallet software, like CoinBase and WarpWallet, and don’t trust Bitcoin exchanges that don’t have reputable names backing them. Pick strong passwords. Don’t pick weak passwords. Use two-factor authentication wherever possible. Don’t download sketchy screensavers. In general, be more paranoid than you think it’s reasonable to be.
You can find exchanges and reviews of exchanges at http://bitcoinx.io/. Make sure to do your background research on any candidates you’re considering. Take the time to do some reading about cryptocurrencies as well. Make sure you understand what they are, how they work, and what sorts of attacks you might be vulnerable to.
Have A Strong Stomach, And Don’t Invest Money You Aren’t Prepared To Lose
One of the things that characterizes bad traders is an inability to stomach drops in the market: they buy only when the market is up, and panic-sell during drops: the opposite of a rational strategy. You’ll do better if you write off any money you invest as ‘probably gone.’ It’ll make it easier to weather the sharp drops in price associated with cryptocurrency trading. Be certain to take advantage of panic drops caused by sudden, unexpected bad news (hours after the closure of the infamous Mt. Gox would have been an excellent time to buy). Keep track of multiple cryptocurrencies: the markets are small enough that, sometimes, arbitrage is possible, and they can be easily traded amongst themselves from your browser, without the need for a messy cash interface.
Following a rational investing strategy has two upsides: one, you have a better chance of turning a profit. Two, you’ll be exerting a stabilizing influence on the market. Stable prices help ease the implementation of cryptocurrencies in their legitimate, interesting role as, you know, currencies.
Seriously, Be Careful
If you’re careful, sober, and take advantage of the swings of the market in a positive, stabilizing way, you may wind up making some money on cryptocurrencies. That does not make you a sharp-eyed fast-talking wheeler and dealer. Don’t quit your day job, don’t bet your retirement fund, and don’t stay in too long if the market really starts to tank.
This is what the graph of Bitcoin’s value over time looks like:
Do you see a pattern there? The structure here is one of bubbles and busts. As Bitcoin is featured in the news, day traders enter the market, drive the price up, then they make their money and start to cash out. The value drops, the day-traders panic, and the price plummets. Then some of them buy back in, and the price starts to recover, driven by a mixture of new investors and old investors looking to make a bigger return. It spikes again… but not quite as high. It is not, of course, guaranteed that this trend will continue — but it seems like a pretty good bet.
The value of cryptocurrencies could be increased, in a sustainable sense, by increasing the number of people who actually want to use cryptocurrencies to buy things: that means making the software easier to use and increasing the number of companies and organizations that accept it. It’ll be a while before these effects really begin to overwhelm the swings of speculation – but, if you plan to hold cryptocurrencies for the long haul, it’s worth considering.
Speculating on cryptocurrencies gives you the opportunity to be involved with and potentially make money on a promising new technology. That said, it isn’t a day job and it isn’t a get rich quick scheme. Be careful and invest responsibly. Lastly, remember to have fun: there’s a reason gambling, an objectively poor investment, has survived as long as it has — people enjoy it. If nothing else, you should get some solid, Skinner-box-esque enjoyment out of your experimentation with cryptocurrencies, so be sure to take advantage.
Full disclosure: I have owned BTC in the past, but do not currently and do not plan to acquire any in the immediate future.
Feature Image Credit: “Prospector” by Tony Oliver