There's been no better asset class to invest in over the past five years than cryptocurrencies, with a return of 9,400% since February 2017. I'm sure this astronomical gain has caught your attention, even though you might not be comfortable with your understanding of the industry.
If you're a crypto newbie, you don't want to overlook these five key factors. They'll round out your knowledge of this complicated asset class before you decide to invest.
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1. Extreme volatility
If you think the stock market is volatile, you're in for a surprise. Digital assets are much more volatile. Even Bitcoin (BTC -1.54%), the world's most valuable, most developed cryptocurrency, experiences price movements of 5% or more regularly.
You know your own emotional and psychological makeup best. So being able to ride out the inevitable ups and downs, and avoiding any panic, is absolutely necessary to give yourself the opportunity to achieve great returns.
It's very important that you understand your investing time horizon as well. If you plan to be an investor for decades, allocating a small amount (1% to 2%) of your portfolio to cryptocurrencies is a smart idea. However, if you're close to retirement, it's probably best to stay away.
2. Show me the utility
I believe that the most critical determinant of whether cryptocurrencies stay relevant and gain importance in the future is if there are real-world use cases. Ethereum (ETH -4.11%) is showing major promise in this regard.
Thanks to its smart-contract functionality, Ethereum has been a popular platform for the creation of decentralized applications, or dApps. These span services ranging from gaming and social media to finance and identity, all without the need for a central intermediary.
Stay away from meme coins like Dogecoin and Shiba Inu. Instead, look for cryptocurrencies that demonstrate the potential for actual utility. Cardano and Solana are two that also stand out.
3. How much developer activity?
In the same vein as looking for use cases, a cryptocurrency's chances of success depend upon the number of developers working on the platform. Although there is a ton of talent gravitating toward the crypto industry, the smartest people are only going to work on the most promising projects.
According to venture investment firm Electric Capital, Ethereum was the top in this category, with 4,000 monthly active developers working on it. Since cryptocurrencies are still such a nascent technology, there are always improvements that can be made to better serve the growing community of users. Therefore, to have a lot of developers working on a particular cryptocurrency shows that there is continuous progress being made.
4. Upcoming catalysts
Before jumping into the crypto waters, it's worth knowing if there are any near-term catalysts that could have a significant impact on a particular coin's price. Usually, projects with more developers will tend to have greater catalysts, as there are always new upgrades being introduced.
Let's go back to Ethereum. It's in the process of transitioning from a proof-of-work consensus mechanism to a proof-of-stake one. This is an immense challenge, exacerbated by the fact that the network is still running while the upgrade is being implemented. Unsurprisingly, there is a lot of uncertainly around the execution of this event. But if it can be integrated with no major issues, you can be sure that Ethereum's market value will rise.
Cardano is also in the middle of adding new scalability and governance features, both of which should support a higher token price.
5. Regulatory framework
This last factor relates to the entire crypto ecosystem, and keeping an eye on it is of the utmost importance. I'm talking about government regulation, which in my opinion is the biggest question mark in regard to the trajectory of the crypto market.
Last year, China effectively made it illegal to hold, mine, or transact in digital assets. And the White House is expected soon to give various governmental agencies the power to study and regulate cryptocurrencies as they deem necessary.
Innovation always moves faster than regulation -- just look at the large tech companies. But if you want to invest in crypto, you should be aware that regulation is changing and constantly developing. And new rules might not be favorable for the industry.
