No. There will always be a measure of risk when “investing” in Bitcoin, Ethereum, or any other form of cryptocurrency. However, that risk can be managed.
In this article, we’ll cover the fundamental points you need to know in order to make a risk-managed investment in cryptocurrency. However, do NOT mistake “risk-managed” for “safe” because they are NOT the same thing. Keep reading to find out why.
How Crypto Investments Work
As with all physical and virtual items, digital coins are subject to supply and demand. At any given moment, there are people who have coins and want to sell them (supply) and there are people who want coins and are willing to buy them (demand). They comprise the coin market.
But not everyone agrees on the value of a coin. Every seller has a minimum price point at which they’re willing to sell, and every buyer has a maximum price point at which they’re willing to buy. Sellers put their coins on the market at a certain price, and prospective buyers buy them.
The current market price of a specific cryptocurrency (e.g. Bitcoin, Ethereum) is the price of the most recently sold coin. As lower-priced coins are bought up, only higher-priced coins remain on the market. As the price goes up, buyers back out and wait for the price to drop.
So how do people make money with cryptocurrency? They buy in at a certain price, wait for the market price to rise, then sell for a profit. However, if the market price never rises above the buy-in price, then selling at a loss is the only option.
In this way, coin investing is similar to stock trading: each coin of a cryptocurrency is like a share in a publicly-traded company, and both coin prices and stock prices are heavily influenced by what buyers on the market are willing to spend.
Why Crypto Investments Are Risky
A coin’s value is directly tied to how much faith people have in it.
If people really believe that Ethereum is the future, then others will jump aboard the wagon — former non-buyers become buyers, and current buyers become more willing to spend to acquire coins. Sellers become emboldened to hold for the future, so fewer sellers exist on the market. The price shoots up.
If people lose faith and stop believing in the longevity of Ethereum, then buyers back out and disappear. Sellers lose hope that their coins will be worth anything in the future, so they decide to dump. But everyone else is dumping too, so everyone undercuts everyone else to offload their coins as fast as possible. The price plummets.
The problem is, there’s only one way to increase faith in a cryptocurrency — through buzz and hype leading to widerspread adoption — but many ways for faith to evaporate.
If you’re reading this article, it’s probably because you’ve heard that you need to invest in Bitcoin (above, first) or Ethereum (above, second) while you still can. Based on these price-over-time charts, you might be tempted to sink your savings into them. After all, look at those spikes!
If you had invested $1,000 into Bitcoin one year ago, today it would be worth $7,194. If you had invested that same $1,000 into Ethereum one year ago, today it would be worth a whopping $28,892. One year! You won’t find that kind of annual return anywhere else.
But high returns come with high risks.
Spikes like this are common in the cryptocurrency world. As of September 2017, CoinMarketCap shows over 1,100 different actively-traded cryptocurrencies, many of which experienced their own big spikes similar to what Bitcoin and Ethereum are going through now.
How did those other cryptocurrencies fare?
Peercoin became big around the end of 2013, skyrocketing in price through the first quarter of 2014 before users lost faith. The price dwindled down and down, with a few hopeful spikes along the way, but never truly recovered. Despite a bump in 2017, likely riding on the coattails of Bitcoin and Ethereum, Peercoin’s price failed to reach even half of its heyday.
Steem is a younger cryptocurrency, just over a year old as of this writing, that exhibits much of the same patterns as older cryptocurrencies: the price sits stagnant for a quite, a spike comes along, users jump on the wagon, realize the hype wave is over, then sell out before the price plummets. Another spike came along in 2017, but without lasting power.
The same thing happened with Dogecoin, which was once the third-largest cryptocurrency in 2014 but is now barely hanging on in the Top 30. Dogecoin is one of the rare examples of a cryptocurrency spiking to a higher price later in its life, but note how quickly the second spike dissipates: it plummets within days, spikes back up, then loses most of its gains again within two months.
And that’s the big risk with crypto investment: you can get rich overnight, but you can also lose it all overnight. Don’t think of it as an investment — it’s a gamble.
Crypto investment is a game of spikes. You need to already be in the game by the time a spike arrives in order to ride it up and give you the room necessary to sell for profit. At the same time, you need to get off that ride before everyone else does, otherwise profits will disappear.
How is crypto investment different from the stock market?
The main issue is a lack of historical data. Cryptocurrencies debuted with Bitcoin in 2009, which means the crypto market hasn’t even been around for a decade. Enthusiasts look at the 2017 spike in crypto interest as a sign of a healthy future, but there’s just no way to know.
When you look at 100 years of stock market history, you’ll see all kinds of mountains and valleys — but you’ll also notice that the big picture always trends upward. Could the stock market crash and never recover? Sure. It happened to Japan in 1990. But the historical data shows that it’s unlikely. When there’s a crash, you can reasonably hope for a recovery.
There’s no basis for such a hope in cryptocurrency. Could Bitcoin and Ethereum soar to higher heights over the next five years? Sure. But could the whole industry collapse and never recover? Absolutely. We simply don’t have enough historical data to do anything more than guess. It’s still too young and there’s too much uncertainty.
My rule of thumb: if you see a spike in cryptocurrencies, you’ve already missed the hype train. Wait for it to drop, buy in, and hold for another spike — but with the understanding that another spike may never come.
Managing Risk When Investing in Crypto
I’m not saying you shouldn’t invest in cryptocurrencies. I personally don’t, but it’s clear that the market is alive and people can still walk away with a killing if they play their cards right.
That being said, here are a few tips to lessen your risk of a total loss:
- Don’t put all your eggs in one basket. On a macro scale, don’t stick your entire portfolio in crypto (up to 5 percent is a smart, conservative move). On a micro scale, don’t stick your entire investment in a single cryptocurrency (diversify between coins that have different missions and use different underlying technologies).
- Only “invest” money you can afford to lose. Again, cryptocurrencies aren’t so much investments as they are speculations. It’s literally a gamble. If you buy into it, expect your coin value to drop to zero and consider it a bonus if it doesn’t.
- Sell your profits. If you make gains, don’t get greedy. Sell a portion of it to realize profit, then see how the remainder performs. If it goes up again, sell another portion. Don’t “wait for the peak” before you sell — a plunge to zero could happen overnight.
- Never store your coins on an exchange. Another MtGox crisis controversy could be right around the corner. Have money in an exchange? Pull it out. Have coins in an exchange? Transfer them to a cold wallet. We recommend the Trezor wallet by Satoshi Labs.
Be careful and good luck! If you have past experiences with Bitcoin, Ethereum, or any other cryptocurrency, please share them with us in the comments.
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