What is cryptocurrency — and is it a good investment?
If you still find cryptocurrency confusing, you’re not the only one.
According to a Huobi report (opens in new tab), almost 30% of U.S. adults own crypto. At the same time, 40% say they’re either “not very knowledgeable” or “not at all knowledgeable” about the digital form of currency.
In other words, even crypto investors are in the dark.
Editor’s Note: This article is designed to help you better understand what cryptocurrency is and how to research your options should you decide to invest. Cryptocurrency is inherently risky, and we are not providing investment advice here.
That helps explain why in March 2021 — when Bitcoin was near its all-time high price— 62% of crypto investors (opens in new tab) believed crypto would make them rich. Four months later, Bitcoin’s price had dropped by nearly 50%.
But it’s not just investors who are confused. In the Huobi survey, financial advisors admitted to their lack of understanding and education on cryptocurrency, and the group listed social media as one of their primary sources on the subject.
If you’re thinking about buying (or selling) crypto, but are unsure if it’s a good idea, social media probably isn’t helping. Consider this information instead.
What is cryptocurrency?
Cryptocurrency is a form of digital money.
It only exists electronically, and unlike paper currency, it’s not backed by any government. Instead, the value of virtual “coins” is determined by the community of people who use them, and values can shift in an instant.
Crypto can be bought, traded, and used for financial transactions online. Investors can also cash out their crypto, or even use it as payment for real-world items at WalMart, Home Depot, Overstock.com and some other major retailers.
Bitcoin, the first and most widely used cryptocurrency, was created by Satoshi Nakamoto in 2009, but today there are over 10,000 different cryptocurrencies in circulation.
How to choose a cryptocurrency
Lots of people take the wrong approach to buying crypto.
An alarming number of would-be investors try to make a purchase by clicking a cryptocurrency ad or responding to a private message that promises the opportunity to get rich quick.
Instead of making an impulse buy, you can take the following steps to vet a cryptocurrency before buying.
Research the currency
Before handing over any personal or financial information, use this checklist to verify that a currency is legitimate, secure, and worth your money:
Choose a platform
Cryptocurrencies are available through many apps and websites, including some you may already use.
Reputable payment platforms like PayPal, Square or even Venmo allow users to choose currency and quickly complete a purchase. Crypto exchanges like Coinbase and Gemini can also be good options.
Which platform should you choose? It depends on how you plan to use the currency.
Will you buy and hold? Will you make frequent trades or occasionally cash out your crypto? Each platform has different fees for these activities, and some may limit the kind of transactions you can make.
Before deciding, be sure to review fees and restrictions, and check the exchange’s security ranking (opens in new tab).
Is cryptocurrency a good investment?
Experts recommend investing a maximum of about 1% to 3% of your total liquid assets into crypto. In other words, only invest money you can afford to lose.
Why so conservative? Because cryptocurrency is one of the most volatile investment classes available, and that means it’s subject to significant price changes, sometimes in the span of just an hour.
Don’t believe the hype
Crypto’s volatility is widely misunderstood. Wishful thinking, and deceptive marketing, tell you that high volatility means there will inevitably be another big price spike. Never mind the possibility of a crash.
As it was frankly put (opens in new tab) in a Substack letter from Benn Eifert, managing member and CIO of QVR Advisors, “The lines between over-optimism, deception, and fraud are not always bright.” One of the red flags he calls out is the extrapolation of recent extreme investment performance into the future.”
In reality, there’s no guarantee that cryptocurrency will increase in value, either overnight or in the long run. In fact, it’s done exactly the opposite in recent years.
Bitcoin, for example, was worth more than $65,000 in November of 2021. A month later, 52% of Bitcoin investors predicted (opens in new tab) it would pass $70,000 by the end of 2022.
Instead the price tumbled, falling below $18,000 in June, and there’s no indication it will rebound soon.
On the upside, falling prices can present a good opportunity to buy.
Intuition might tell you to shy away from an investment that’s losing value, but when prices fall, you can buy a larger amount of crypto for less money.
Just keep in mind that prices may continue to drop, and there’s no guarantee they’ll ever rebound. If you’re interested but hesitant, consider starting small and then watching how your investment performs.
Several platforms, including Robinhood and Venmo, let you start with as little as $1.00.
Crypto: reasons to be wary
Cryptocurrency has come a long way.
Its main use isn’t just to shield illicit transactions on the black market anymore. In fact, crypto transactions have proven to be more traceable than expected (opens in new tab), even more so than cash. Some crypto exchanges now offer insurance against certain losses, too.
But there’s no way of knowing whether or not cryptocurrencies will be valuable in the future. Here are a few more good reasons to think twice before investing serious money into crypto.
- Capital gains taxes. The money you make when you sell your crypto could be taxed (opens in new tab) at a rate as high as 37%.
- Lack of professional guidance. Nearly 30% of financial advisors say they lack the understanding needed to invest in crypto, and 18% don’t feel comfortable talking to clients about crypto.
- Security issues. Cryptocurrency is subject to hacking and theft, and its investors aren’t fully insured against losses.
- Scams. Consumers have reported $575 million in losses to crypto investment scams to the Federal Trade Commission (FTC) since 2021.
- Pending regulation. Cryptocurrency will likely be subject to more regulation and taxation in the future. The majority of U.S. states, for example, are currently working to pass new legislation on virtual currency.