Cryptocurrency, Blockchain, and Bitcoin Investing

It's easy to see the allure of cryptocurrency investments. Fortunes have been made from these digital assets, and many people became wealthy by investing only meager sums. But can cryptoassets make you rich from this point forward?

By Joe Tenebruso (TMFGuardian)

Cryptocurrency has captured the imagination of investors all around the world. These digital currencies use cutting-edge cryptography -- secure, coded communication -- to secure and verify transactions with the help of a technology called blockchain. A blockchain is a growing list of records, called blocks, that are linked using cryptography; each block contains a coded version of the previous block, making the data difficult to modify. In this way, new units of currency are created, code becomes law, a decentralized network of computers replaces central banks, and value is digitized. It's a futuristic version of money and asset creation -- and many people believe cryptocurrency will help to reshape the global financial system in the coming decade.

It's easy to see the allure of cryptocurrency investments. Fortunes have been made from these digital assets, and many people became wealthy by investing only meager sums. But can cryptoassets make you rich from this point forward?

Bitcoin is the best-known cryptocurrency at the moment, but new ones are always emerging. Image source: Getty Images

The Cryptocurrency Market

The crypto industry's origins trace back to the 2009 creation of Bitcoin, now the world's most popular cryptocurrency. With the release of a whitepaper, Satoshi Nakamoto, Bitcoin's pseudonymous creator, unveiled plans for a "peer-to-peer electronic cash system." Nakamoto proposed the creation of a digital ledger, or blockchain, which would be maintained by a distributed group of computers around the world. These "nodes" would help to secure Bitcoin's network and validate transactions. Bitcoin quickly gained favor with cryptography and digital-asset enthusiasts, and it eventually went on to become the most valuable cryptocurrency out there, with a market value of more than $100 billion.

Bitcoin's success ushered in a wave of technological innovation in the crypto market. Several other cryptocurrencies would also go on to be worth billions of dollars, including Ethereum, a global, open-source platform for decentralized applications; Ripple, a cross-border payments network; and Monero, a privacy-focused cryptocurrency. Today, there are more than 2,000 different cryptocurrencies that are together valued at more than $200 billion.

Cryptocurrency trading mostly takes place on cryptocurrency exchanges. Popular exchanges include Coinbase and Binance. Hundreds of millions of dollars' worth of cryptoassets trade on these exchanges every day. In turn, these highly profitable financial institutions have grown to become billion-dollar enterprises.

How to Invest in Cryptocurrency

If you'd like to invest directly in cryptocurrencies, you can do so by opening an account at a leading exchange. Coinbase is a top choice for many U.S.-based investors, while Binance is a favorite for many international crypto investors. You can transfer funds from your bank account to Coinbase and quickly begin to purchase cryptocurrencies. Many exchanges, including Binance, allow their customers to purchase cryptocurrency with debit and credit cards.

Mobile applications such as Robinhood and Square's Cash App also allow their users to purchase cryptocurrencies. Square charges no fees when you buy or sell Bitcoin on its popular mobile payment app. Robinhood, meanwhile, offers commission-free trades in Bitcoin and other cryptocurrencies.

Some investors may prefer to purchase cryptocurrency-related investments in their traditional brokerage accounts. The Grayscale Bitcoin Trust (NASDAQOTH: GBTC) was created for this purpose. The trust is designed to act as a proxy for the price of Bitcoin; shares of the trust are backed by roughly 0.001 Bitcoin each. So in theory, its share price, when multiplied by 1,000, should roughly equal the price of one Bitcoin. However, Grayscale Bitcoin Trust typically trades for a sizable premium over the value of its Bitcoin assets. Investors should thus weigh whether holding Bitcoin-related assets in their brokerage accounts is worth the added cost compared with buying the cryptocurrency itself on a crypto exchange.

Futures contracts offer investors another means to speculate on the price of cryptocurrency. Futures contracts are binding agreements that allow people to make bets on whether an asset's price will rise or fall over a certain period of time. They also allow for the use of leverage, though this increases risk, as leverage can amplify both gains and losses. In the case of cryptocurrency futures, most contracts are for Bitcoin, though several trading platforms plan to roll out futures contracts for additional cryptocurrencies in the future.

Should I Invest in Cryptocurrency?

The potential benefits of cryptocurrency investing are rather straightforward. Many digital assets have seen astronomical returns in recent years, with some cryptocurrencies rising more than 100 times in value in just a single year. Owning and managing cryptoassets also allows you to latch onto a piece of the future, as many crypto projects are seeking to disrupt massive industries with potentially game-changing new technologies.

However, investing in digital currency is not without risks. Many cryptocurrencies have seen their value plunge during the industry's vicious bear markets. Additionally, scams, frauds, and theft are rampant within this largely unregulated corner of the financial world -- all of which have led to painful losses for some investors.

Crypto Taxation

As with most other investments, cryptocurrency gains are taxable. Tax laws related to cryptoassets are in a state of flux in many areas of the world, so it's best to check with your tax professional to see whether you owe taxes if you've invested in cryptocurrencies.

Generally speaking, you may owe taxes any time you sell a cryptocurrency for more than what you paid for it. Alternatively, should you sell cryptocurrency for less than what you purchased it for, you may be able to write off those losses to offset your other investment gains or taxable income. Again, it's best to check with your accountant as to whether this applies to your personal situation.

If these transactions occurred on an exchange, you may be provided with a transaction history report that you can use to calculate your taxable gains or losses. If these crypto transactions occurred elsewhere, you'll likely need to record them yourself for tax purposes.

What the Pros Think About Crypto

Opinions on cryptocurrency's suitability as an investment vehicle vary widely. Warren Buffett -- the legendary investor and CEO of $500 billion mega-conglomerate Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) -- is not a fan of Bitcoin, to say the least. In fact, he once referred to the popular cryptocurrency as "rat poison squared."

Although he acknowledges that aspects of Bitcoin are "ingenious" and that blockchain technology "is very big," Buffett has given multiple reasons why he's not a fan of Bitcoin as an investment. "It's a gambling device ... there's been a lot of frauds connected with it. There's been disappearances, so there's a lot lost on it. Bitcoin hasn't produced anything," Buffett said during a Berkshire Hathaway annual shareholder meeting.

Buffett also said that Berkshire is unlikely to ever invest in cryptocurrencies, though he admitted that his knowledge of the nascent asset class is somewhat limited.

"We don't own any, we're not short any, we'll never have a position in them," Buffett said during an interview with CNBC. "I get into enough trouble with the things I think I know something about. Why in the world should I take a long or short position in something I don't know about?"

However, other billionaires have a far different view of cryptocurrency. Jack Dorsey, the CEO of social-media giant Twitter (NYSE: TWTR) and financial-services leader Square (NYSE: SQ), is an ardent crypto bull. Dorsey envisions a future in which a cryptocurrency -- most likely Bitcoin -- becomes the internet's native currency.

"We have all these currencies for every nation-state, but if you consider the internet to be the equivalent to a nation-state, it will have a currency native to itself, and there is not going to be any one party or institution that makes this happen, and there's not going to be any one party or institution that can stop it from happening," Dorsey said during an interview with Quartz. "And having a global currency that is native to the internet will allow companies like ours to move much faster and reach a lot more people."

The potential for Bitcoin to eventually become a truly global currency is one of the reasons why billionaire venture capitalist Tim Draper believes its price could reach $250,000 per coin by 2023, up from about $10,000 today. "It's a better currency. It's decentralized, open -- it's transparent; everybody knows what happens on the blockchain," Draper said during an interview with Fox Business.

And Draper isn't the only notable investor who believes Bitcoin could still rise many times in value from today's levels. PayPal (NASDAQ: PYPL) director and serial entrepreneur Wences Casares is among several investors who believe Bitcoin could one day reach $1 million per coin.

As can be seen, views on cryptocurrency vary greatly. And as with any investment, whether cryptocurrency investing is suitable for you depends on your personal risk tolerance, goals, and comfort level with this asset class.

Finding the Cryptocurrency Investment Strategy Right for You

Before you invest directly in cryptocurrency, you should determine whether you're comfortable with the risks outlined above -- and the knowledge that there are probably even more unknown risks. You'll be investing in technology that is still largely unproven. Moreover, cryptocurrency prices are notoriously volatile. Gains and losses of 20% or more in a single day -- or even an hour -- are not uncommon. You'll also need to accept the potential for a complete loss of your investment capital, should the cryptocurrency project you invest in fail and its price descend towards $0.

It's certainly possible that cryptocurrency can make you rich -- there are many success stories that have shown this to be true -- but there's likely a greater probability that you'll lose money. Investors should factor this into their decisions and plan accordingly.

Using the Asymmetrical Risk/Reward Profile of Cryptocurrency to Your Advantage

In this regard, the concept of asymmetric risk may prove helpful. While most cryptocurrency projects will likely fail, some may go on to produce spectacular returns. In turn, many cryptoassets will ultimately become worthless, but a select few may rise 10 or even 100 times in value or more. One way to account for this -- and to use it to your advantage -- is to invest a relatively small amount of your investment capital in cryptocurrencies, perhaps 1% to 3% of your total portfolio. This way, if your crypto investments perform well and rise multiple times in value, you'll still profit handsomely, but even if they go to zero, your portfolio won't suffer much damage.

Blockchain-Related Stocks as a Crypto Strategy

In addition to investing directly in cryptocurrencies (or crypto-derivative products such as futures, explained below), there's another -- and potentially far safer -- way to profit from the growth of the crypto market. This cryptocurrency investment strategy involves buying stock in businesses poised to benefit from crypto and blockchain technology. Companies such as CME Group (NASDAQ: CME), which operates the leading bitcoin futures exchange, and Facebook (NASDAQ: FB), which is launching a new digital currency called Libra, stand to profit handsomely from their crypto-related initiatives, but they also enjoy multiple other high-margin revenue streams that can continue to propel their growth should the crypto market's growth fall short of expectations.

Should you decide to invest in companies such as these, you could dedicate larger sums to those relatively safer investments, perhaps on the order of 5% or less of your investment portfolio in each stock. As part of a well-chosen, diversified portfolio of 15 or more high-quality companies, blockchain stocks can help you build long-term wealth.

Combining Cryptocurrencies and Stocks in Your Investment Strategy

The best option may be a combination of these two approaches -- smaller direct investments in cryptoassets and larger investments in a diversified collection of blockchain-related (and non-blockchain-related) stocks. Such an investment strategy could give you multiple ways to profit from this potentially world-altering technology in the years ahead, while also helping you lessen the overall risk profile of your investments via diversification.

Ultimately, of course, you'll need to decide whether investing in cryptocurrency and blockchain stocks is the right choice for you.

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