Investing In Cryptocurrencies - The Ultimate Guide

So, you’ve decided to get exposure to cryptocurrencies. In this newer space, a personal financial advisor may not be of great help. Neither will your banker, unless you are a customer of a limited number of progressive Swiss private banks, which facilitate crypto trading. What now? This article provides practical information and resources around passive vs. active cryptocurrency investing, how to buy, sell, store, and monitor cryptocurrencies, as well as tax regulations in the space.

Introduction

So, you’ve decided to get exposure to cryptocurrencies. Perhaps you are seeking a geopolitical hedge against political and economic uncertainty, or perhaps you’re excited by the buzz and want in. What now? In this newer space, a personal financial advisor may not be of great help. Neither will be your banker, unless you are a customer of progressive Swiss private banks like Falcon or Swissquote, which facilitate crypto trading. This article provides practical information and resources around passive vs. active cryptocurrency investing, how to buy, sell, store, and monitor cryptocurrencies, as well as tax regulations in the space. As a private investor in cryptocurrencies, partner of cryptocurrency hedge fund Q2Q Capital, and overall cryptocurrency enthusiast, I’m excited to see how the space progresses and how acquisition will become ever-easier.

A quick caveat: This article will not cover deciding whether to invest in cryptocurrencies and how large the portfolio allocation should be. However, in deliberation, you should consider everything from your age, wealth, risk tolerance, and exposure to other asset classes to your level of conviction in various cryptocurrencies. You’ll need to read white papers as well as browse relevant materials on online forums and social media like Twitter, Reddit, Medium, and cryptocurrencies’ GitHub accounts. You’ll also need to determine the type of exposure you want. After all, virtually everyone is familiar with Bitcoin (BTC), but most do not know that there are well over a thousand cryptocurrencies—1384 as I write this.

Passive vs. Active Investing in Cryptocurrencies

I find it useful to think of cryptocurrencies as a new asset class, which allows us to compare their investment approaches to more established asset classes, such as equity investments. For example, one of the biggest topics of discussion in the equity investment space involves the merits of passive vs. active investing. The debate between the two approaches and their relative merits and risks is enough to create a dissertation and is beyond the scope of this article. However, generally speaking, passive investing is aimed at the longer term, requiring a “buy-and-hold” mentality, while active investing is more hands-on.

For example, in the context of equity investing, you’d need to decide whether to buy a broadly-exposed fund like an S&P 500 index fund or an actively managed fund where the fund manager engages in stockpicking. Alternatively, you could actively manage the portfolio yourself by doing your own stockpicking and monitoring. The same approaches exist in the cryptocurrency space, though many products are more nascent and in development.

Active Investing

BUYING AND SELLING CRYPTOCURRENCIES YOURSELF

Buying Exchanges

By far the most popular way to trade cryptocurrencies is via a cryptocurrency exchange. Cryptocurrency exchanges are websites where individuals can buy, sell, or exchange cryptocurrencies for other digital currency or traditional paper (“fiat”) currency. Most exchanges convert cryptocurrencies into other cryptocurrencies; that is, you can use one cryptocurrency to buy another, but you cannot use your fiat money (like US Dollars). Some of the largest exchanges include Poloniex, Bitfinex, Kraken, and GDAX, which trade more than $100 million (equivalent) per day.

Still, some exchanges accept fiat money, where you would fund your account by wire transfer. Some exchanges even allow credit card purchasing of crypto, although usually in limited amounts and at high fees (e.g., 3.99% at Coinbase, the largest US-based exchange). The exchanges that accept fiat are typically limited to only a few prominent cryptocurrencies (e.g., Bitcoin, Bitcoin Cash, Ether, and Litecoin), which you can then in turn use to purchase other, lesser-known cryptocurrencies. You can refer to this site to research which exchanges are accessible from a specific country or accepts specific payment methods.

Exchanges also differ in important aspects. For one, the Know-Your-Client (KYC) guidelines whereby exchanges require certain information about the user may be more or less extensive. However, most exchanges nowadays—and certainly the ones dealing with fiat money—require user identification and proof of residence. Additionally, fees differ by exchange, but often range of 0 – 0.5%. Some exchanges also offer value-added features, such as Coinbase’s Vault, which stores coins you are not trading in the short-term in what they claim to be a more secure manner. Lastly, some user interfaces are “cleaner” while others are “busier,” though this is a matter of personal preference.

Finding a Counterparty

Another “traditional” way is finding a counterparty (buyer or seller) yourself. You will need a wallet to either send or receive the cryptocurrency. Say you want to buy some BTC for fiat: you would provide the seller with the public key of your wallet and would pay the fiat money once the BTC has hit your wallet. A well-known method of facilitating these peer-to-peer transactions is via localbitcoins.com. Needless to say, you will want to conduct such transactions in a safe, public environment—perhaps in the context of a meetup of a local cryptocurrency group (which you can find via sites like meetup.com).

Crytocurrency ATMs

There are now a number of companies setting up cryptocurrency ATMs for cryptocurrencies like BTC, Litecoin, Ether, Dash, and more. Currently, these ATMs are most abundant in the US (1,188), Canada (314), and the UK (104), as set up by around 20 manufacturers. You can use this site to find an ATM near you.

You usually feed fiat money into the ATM and it will provide you with the private key you need to access the cryptocurrency acquired. Though they look like traditional ATMs, BTC ATMs connect to a BTC exchange and not a bank account. Once acquired, you can transfer the cryptocurrency elsewhere, like to a crypto-to-crypto exchange. The disadvantage is that fees are typically high, sometimes reaching up to 7% of the transaction. You will also either need an existing virtual crypto wallet, which you can set up online, or an ATM that provides a temporary wallet. Cryptocurrency wallets allow users to send and receive digital currency and monitor their balance. They can be either hardware or software, though hardware wallets are considered more secure.

Directly via Private Bank Account

As noted previously, Swiss banks Falcon and Swissquote are currently offering cryptocurrency trading to their clients. As of August 2017, Falcon Private Bank, in collaboration with broker Bitcoin Suisse AG, will enable customers to trade Ether, Litecoin, BTC, and Bitcoin Cash—though the implications for preserving anonymity are unclear. Online bank Swissquote offers trading with these same four cryptocurrencies plus Ripple, and also released an exchange-traded, actively managed BTC certificate. This certificate was built to manage price volatility by switching investor holdings between BTC. For example, it might increase the amount of cash during downturns or periods of uncertainty. The product claims to use an advanced algorithm to determine the shifts between BTC and cash.

The advantages of going through a bank include not having to deal with a new bank (for some), open up a separate exchange account, or set up secure storage for your cryptocurrencies. I expect more banks to follow suit over time.

Selling

Once you are ready to sell some or all of your cryptocurrencies, the same avenues you used for purchasing are available. That is, you can sell on an exchange, directly to another person, or even at an ATM.

As with buying, you will be able to trade cryptocurrencies directly for fiat money on certain exchanges. But in other cases with smaller cryptocurrencies, to gain fiat money, you will need to take the intermediate step of selling your cryptocurrencies for a “mainstream” cryptocurrency such as BTC or Ether, which you can then sell for fiat money. This will obviously involve two transactions, double the fees, and a longer period of market risk exposure. It’s important to note that in this very young market, liquidity may not exist at the exact moment when you want it—including situations when crypto exchanges are down—and especially during times of rapid market movement.

An additional method of “selling” is via debit cards where you can spend cryptocurrency directly from your virtual wallet, such as those provided by TenX (for BTC, Ether, and soon ERC-20 tokens and Dash) or Xapo (for BTC only). These debit cards reflect the balance of cryptocurrencies you own. When you use them with vendors, your cryptocurrencies are automatically converted to fiat currency; for the merchant, the payment will look the same as a prepaid or regular bank card. Considering that many cryptocurrency owners are holding for investment, with over half of BTC’s 10 million holders holding purely for investment purposes, these debit cards represent an effort to further mainstream adoption and integrate cryptocurrencies into everyday transactions.

A Quick Word on ICOs

Initial coin offerings, known as ICOs, are a rising phenomenon within the crypto world. In essence, they help firms raise cash for the development of new blockchain and cryptocurrency technologies. And, instead of (or sometimes in addition to) issuing shares, they offer digital tokens, otherwise known as “coins.” To demonstrate the popularity of ICOs, consider that celebrities such as Floyd Mayweather and Paris Hilton are now aggressively investing in and promoting them. Or, the fact that in 2017, former Mozilla CEO Brendan Eich raised $35 million from an ICO in under 30 seconds.

You can typically participate in ICOs by sending cryptocurrencies to a wallet specified by the ICO issuer. However, it’s important to note that scams have frequently occurred at this step, with many buyers directed by impostor websites to wallets not belonging to the issuer. You may well hardly be able to sell until the newly issued cryptocurrency is accepted for listing on an exchange. Though popular, ICOs carry a lot of risk, are not suitable for crypto beginners, and require a multitude of additional considerations.

OUTSOURCING ACTIVE INVESTING

Alternatively, if you prefer to outsource your active investing, there is an ever-growing number of funds you can leverage. They range from hedge funds such as Metastable Capital, BlockTower Capital and Q2Q Capital, where I am a partner, to BTC mining funds like Logos Fund and blockchain investment firms such as Polychain Capital. The number of cryptocurrency funds has exploded in recent years, reaching around 175 funds with an estimated $3 to 4 billion in assets under management in 2017.