Digital currencies like Bitcoin and Ethereum have been an increasingly popular target for investors in recent years. If you’re used to stock trading, though, the process of buying digital currencies can seem daunting. These currencies trade outside of normal exchanges and rely on digital wallets that most investors don’t already have. In addition, there are a number of investing risks that are unique to digital currencies.
In this guide, we’ll cover everything you need to know about how to invest in digital currency and explain how you can get started.
What Is Digital Currency?
Digital currency – commonly known as cryptocurrency – is a form of decentralized money that only exists as bits on the Internet.
Digital currency is different than cash you access electronically using a debit card or online bank account in several key ways. First, whereas traditional electronic cash can be withdrawn as physical dollars and cents, digital currencies have no physical paper or coin. They can only be transferred electronically.
Second, and more important, digital currencies are decentralized. That means that no one entity controls a digital currency or tracks transactions. Rather, when you make a transaction using a cryptocurrency, the transaction itself is recorded in a public ledger known as a blockchain. That ledger is then distributed across millions of computers so that everyone who uses the currency can keep track of transactions.
Finally, since digital currencies are not sponsored by a government or another single entity, they’re not backed by anything. While that’s also true of the US dollar, supply and demand of the dollar is controlled at least in part by the US government. The value of digital currencies is entirely dependent on the forces of supply and demand in the online market.
Popular Digital Currencies
Bitcoin, the first modern digital currency based on a digital blockchain ledger, launched in 2009. Since then, more than $645 billion has been invested in Bitcoin and this remains by far the most popular digital currency. More than 2,000 additional cryptocurrencies have been created, among the most popular of which are Ethereum (worth $123.5 billion), Tether ($24.2 billion), Ripple ($13.5 billion), and Litecoin ($9.0 billion).
Risks Involved With Investing In Digital Currency
Investing in digital currency is much riskier than investing in traditional assets like stocks or forex (physical currencies). Let’s take a look at some of the key risks that new investors should be aware of.
While all investments experience some volatility, digital currencies can make even penny stocks look stable. In a two-year span from 2017 to 2019, Bitcoin went from $800 per coin to over $19,000 per coin to under $4,000 per coin. On a day-to-day basis, Bitcoin routinely fluctuates up and down by several percentage points. Less popular cryptocurrencies are even more volatile.
For investors looking to buy a cryptocurrency and hold it for the long term, this volatility might not be a huge issue. But it can cause significant problems if you’re trying to time the market or looking for a good entry point into digital currencies.
Digital currencies are not regulated by financial watchdogs, central banks, or any other government entity. That means there are few safeguards to prevent scams or to protect you against losses due to malpractice on the part of a digital currency broker.
Security has been a perennial problem for digital currencies, in part because there are so many links in the chain for hackers to exploit. Malicious actors have in some instances hacked a currency’s digital infrastructure and manipulated the blockchain ledger that records transactions. In other cases, individuals’ digital wallets have been hacked and their investments stolen. Since there are no regulations, there are no security standards and you have no recourse if you lose money because of a security breach.
How To Invest In Digital Currency
Investing in digital currency can be relatively simple if you’re buying a popular currency like Bitcoin. Bitcoin has become popular enough that some brokers and financial services like PayPal enable you to buy or sell this cryptocurrency. In that case, you can trade Bitcoin just like you might trade a stock or convert dollars to pounds.
However, if you want to invest in a lesser-known digital currency, the process is much more complex. To get started, you’ll need a digital wallet and a digital currency broker.
Digital Currency Wallets
A digital currency wallet, also known as a cryptocurrency wallet, is the electronic account where your digital coins are stored. In essence, it’s a bank account for digital currency – except without the bank.
To set up a digital currency wallet, you’ll need to download a wallet software. There are many different options that differ slightly in security features, asset management tools, and whether they can be connected to a broker. Some options include:
- Coinbase – connected to Coinbase, a digital currency broker
- Mycelium – mobile-only and only supports Bitcoin
- Trezor – a dedicated piece of hardware that connects to your devices
When choosing a wallet, you can either manage your own encryption key or, if it’s connected to a digital currency broker, have your broker manage your key for you. In the latter case, your wallet operates much like a traditional brokerage account.
Managing our own encryption key is more secure. However, if you decide to manage your own key and lose it for any reason, there is no way for you to break into your wallet and your digital currency is essentially lost.
Digital Currency Brokers
Digital currency brokers are often called cryptocurrency exchanges. These brokers accept US dollars and allow you to buy Bitcoin and other digital currencies. Some brokers only allow you to buy and sell Bitcoin or a few other popular currencies, while others let you buy and sell hundreds of different cryptocurrencies.
Brokers also vary in other important ways. They charge different commissions and spreads for buying and selling digital currencies. They also offer different trading platforms, which may be tailored towards beginner cryptocurrency investors or advanced day traders. Some digital currency brokers are working with government regulators and banks to increase their trustworthiness, while others are completely unregulated.
If you’re just getting started, Coinbase and Binance are two of the most popular digital currency exchanges. Coinbase offers an integrated digital wallet and its trading platform is relatively beginner-friendly. Binance has a complex pricing structure that can be more favorable for frequent trading, and it also offers debit cards that allow you to spend the digital currency in your wallet.
Other popular cryptocurrency exchanges include Coinmama, Bitfinex, eToro, and Kraken.
Conclusion: Investing In Digital Currency
Digital currencies like Bitcoin and Ethereum have grown immensely in value in recent years. While the future of these coins is far from certain, some investors believe that digital currency will grow to overtake traditional currencies in the coming decades.
If you’re interested in investing in digital currency, you’ll need a wallet and a digital currency broker to get started. Keep in mind that cryptocurrencies have a number of unique risks, so it’s important to do your research before diving into this asset class and to be prepared for volatility.