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What You Should Understand Before Making a Cryptocurrency Investment

When it comes to cryptocurrencies, one of the biggest challenges for investors is not getting caught up in the hype. Digital currencies have quickly risen to prominence in the portfolios of many retail and institutional investors. At the same time, analysts have continued to caution investors about the volatile nature and unpredictability of cryptocurrencies.

If you’ve decided to invest in the cryptocurrency market, it’s important, as with any other investment, to do your research. Below, we’ll explore what you should know before you invest.

Key Takeaways

  • When it comes to cryptocurrencies, one of the biggest challenges for investors is not getting caught up in the hype.
  • Take time to learn about the different currencies offered, in addition to researching blockchain technology such as consensus mechanisms.
  • Understanding the differences between a hot and cold wallet; consider investing in both.
  • There are many primers on blockchain technology that are accessibly written for the layperson in addition to technical white papers.
  • As you begin moving money around networks, perform test transactions to ensure your transfers are successful.

Consider Why You Are Investing in Cryptocurrency

Perhaps the most fundamental question you should ask yourself before making a cryptocurrency investment is why you’re doing it. There are myriad investment vehicles available, many of which offer greater stability and less risk than digital currencies.

Are you interested simply because of cryptocurrency’s trendiness? Or is there a more compelling reason for an investment in one or more specific digital tokens? Of course, different investors have various personal investment goals, and exploring the cryptocurrency space may make more sense for some individuals than for others.

To start, begin by taking a comprehensive approach of evaluating your personal risk appetite, investment goals, and portfolio diversification. You may be interested in cryptocurrency as an alternative asset to what you already hold. You may also be interested in potentially higher returns with the understanding that this reward comes with potentially higher risks. Before investing in cryptocurrency, gain a personal understanding of what you hope to achieve as this will help set the course for your actions. 

Secure Your Keys

In cryptocurrency, a private key is a secret alphanumeric code that allows a user to access and control their digital assets. In a way, it's basically just the password that grants ownership and control of the funds associated with a specific cryptocurrency address. Anyone who has access to the private keys of an address has access to all of the funds in that address. This is why it's essential to keep private keys secure and never share them with anyone.

Private keys are typically generated by a cryptocurrency wallet, and your keys are automatically generated. It's important to note that if a user loses their private key, they'll lose access to their funds forever. Therefore, it's crucial to keep private keys safe and secure by storing them offline in a cold wallet or using a reputable custodial service.

In addition, keeping your cryptocurrency on exchanges in a simple way to keep your cryptocurrency liquid and easy to exchange. However, because exchanges technically have access to your keys in this case, you may be more susceptible to losing your funds should the exchange fail or be hacked. Consider solutions to safely storing your private keys such as writing them down using an old fashioned paper and pencil. 

Your keys are a series of words that are virtually impossible for hackers to guess. Never tell anyone your keys, and store them in a safe location.

Get a Feel for the Industry

It’s essential for investors—particularly those who are new to digital currencies—to develop a sense of how the digital currency world works before investing. Take time to learn about the different currencies offered. With thousands of different coins and tokens available, it’s crucial to look beyond the biggest names like Bitcoin or Ether. 

In addition, it’s important to explore blockchain technology to get a sense of how this aspect of the cryptocurrency world works. For example, every blockchain has a consensus protocol to ensure the integrity of the ledger. However, there are different types of consensus protocols. For example, proof-of-work protocols are those that require substantial mining set-ups to validate transactions. Meanwhile, proof-of-stake protocols reward holders with the highest stakes with validation rewards. 

Understanding different aspects of this may impact your investment. For instance, you may be able to stake your cryptocurrency to generate rewards and increase your holdings. On the other hand, proof-of-stake coins may be inflationary if the rewards given to validators is not closely monitored. 

You can earn passive income from cryptocurrency via staking rewards.

Consider Hot and Cold Wallets

When you buy a cryptocurrency, you can store it in a cold wallet or a hot wallet. The main difference between a hot and cold wallet is their level of security and convenience. Hot wallets are convenient for frequent trading and spending of cryptocurrency but are more vulnerable to hacking and theft. Cold wallets are more secure but less convenient for frequent use. 

The main difference is the connectivity to the wallet. A hot wallet is connected to the internet and can be accessed easily. Examples of hot wallets include online exchanges, mobile wallets, and software wallets. Though hot wallets are great for ease of transacting, hot wallets are also more vulnerable to hacking and theft. If a hacker gains access to your hot wallet, they can potentially steal all your cryptocurrency holdings.

A cold wallet, on the other hand, is not connected to the internet. This type of wallet may be a hardware wallet or paper wallet. Though a cold wallet offers a higher level of security, they are more difficult to transact with. Though they are not vulnerable to online attacks or hacking attempts, it's harder to buy and sell securities from a cold wallet. 

As you embark on your cryptocurrency journey, consider which wallet makes more sense to you. In many cases, investors have both and store more material values or more valuable cryptocurrency via their cold wallet. Then, any balances they may be willing to lose or wish to play with may be kept on the hot wallet. 

Read Cryptocurrency White Papers

More important than word of mouth, though, are the specifics of a digital currency itself. When you’re considering an investment, take the time to find the project’s white paper. Every cryptocurrency project should have one, and it should be easily accessible (if it’s not, consider that a red flag).

Read the white paper carefully; it should tell you everything about what the developers of the project intend for their work, including a time frame, a general overview, and specifics about the project. If the white paper does not contain data and specific details about the project, that is generally seen as a negative. The white paper is a development team’s chance to lay out the who, what, when, and why of their project. If the white paper feels incomplete or misleading, then it might speak to fundamental issues with the project itself.

In addition, developers may issue updates to their white paper, especially as it surrounds their development road map. Be wary of projects whose timelines continually shift with minimal progress.

Perform Test Transactions

Cryptocurrency is unlike banks in many aspects. One of the most vital reasons to understand this is should you accidently send money to the wrong place, it may be impossible (literally) to recover. In some cases, you may lose your money forever.

As you join the cryptocurrency world, understand the importance of test transactions. Test transactions are an essential step when sending cryptocurrency because they allow you to confirm that the transaction will be successful before sending a significant amount of funds. Though they result in higher fees, they very well may be worth preventing a large error.

Test transactions involve sending a small amount of cryptocurrency to a test address. It is meant to simulate a real transaction without actually sending funds to another party. This allows you to test the sending and receiving process, confirm that your wallet is working correctly, and ensure that you have the correct address for the recipient. Once the test transaction has successfully been performed, you can copy the same transaction information for larger exchanges.

A test transaction should be a small such as $1.00; once the transaction goes through, you'll know you can send larger amounts.

Patience Is Key

After diligent research, you have likely developed a feel for the cryptocurrency industry and may have determined one or more projects in which to invest. The next step is to time your investment. The digital currency world moves quickly and is known for being highly volatile.

Remember that digital currencies are highly speculative. For every overnight bitcoin millionaire, many other investors have poured money into the virtual-token realm only to see that money disappear. Investing in this space means taking a risk. By doing your homework before making an investment, you help give yourself the best chance of success.

What Is Cryptocurrency?

VIDEO: What you should know before investing in crypto
CNBC International

Cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.

Is Investing In Cryptocurrency a Good Idea?

VIDEO: How To Invest In Crypto For Beginners [Full Guide]
Lark Davis

While analysts caution investors about the volatile nature and unpredictability of cryptocurrencies, some investors are willing to take the risk for the potential reward. It’s critical to do your research beforehand to determine if investing in cryptocurrency is right for you.

How Do I Learn More About Crypto I Want To Buy?

VIDEO: How to Invest in Crypto in 2023 - Full Beginner’s Guide
Brian Jung

To learn more about cryptocurrencies, join an online community of cryptocurrency investors and enthusiasts, such as that found on Reddit, to see what the community is discussing. Read the white paper that outlines specific details about the cryptocurrency project that you’re considering. Every project should have an easily accessible white paper—if it’s not, consider that a red flag.

The Bottom Line

When it comes to cryptocurrencies, one of the biggest challenges for investors is not getting caught up in the hype. Analysts continue to caution investors about the volatile nature and unpredictability of cryptocurrencies. If you’ve decided to invest in the cryptocurrency market, it’s important—same as with any other investment—to do your research. Consider why you’re interested in this particular investment vehicle, and familiarize yourself with cryptocurrencies and blockchain technology, to be more fully equipped to determine whether this type of investment opportunity is worthwhile for you.

Investing in cryptocurrencies and initial coin offerings (ICOs) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or ICOs. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date when this article was written, the author owns Bitcoin and Ripple.


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