Cryptocurrencies have been red hot in 2020. Note that the year-to-date return for bitcoin is over 100%.
A cryptocurrency is a digital currency that is usually secured by a blockchain technology, which helps with transparency and tracking. It is also something that is not issued by a central authority. Some of the advantages of a cryptocurrency include: there is no need to deal with an intermediary like a bank; transactions can be made without disclosing your personal identify; and the fees are generally low, especially for foreign transactions.
But of course, Cryptocurrencies have notable risks. For example there is often wide swings in valuations. There are also potential issues with hacks of the underlying system, which could mean losing access to the cryptocurrency. The most famous example of this happened with the Mt. Gox implosion, which resulted in the loss of 850,000 of bitcoins.
And finally, the taxation and regulatory standards are far from settled.
So then, what are some ways to lower the risk factors when investing in cryptocurrencies? Well, there are a variety of ways to lower your risk when investing in cryptocurrencies. Let’s take a look:
- Learn The Fundamentals
- Take Security Measures
- Use Exchange-Traded Funds (ETFs)
Learn The Fundamentals of Cryptocurrencies
Understanding cryptocurrencies is far from easy. There are complex underlying technologies. And the market is constantly changing.
Thus, before investing, it is a good idea to learn more about the fundamentals. The good news is that there are many free resources to help out.
“Binance is the largest cryptocurrency exchange in the world, and has really taken their leadership role seriously,” said Kaitie Zhee, who is the founder and CEO of Spacemade X. “They have something called Binance Academy which is a free cryptocurrency and trading education and information resource. They have done an outstanding job in my opinion of making the information easy to navigate, including identifying information for beginners versus more advanced content. All pieces I’ve read from Binance Academy have been concise, giving the readers the full information without overloading them.”
Research, Research, Research
Keep in mind that there are over 2,000 cryptocurrencies. In other words, when it comes to researching opportunities, you will probably only have time to devote to a small number of options.
But when doing your due diligence, it is important to focus on those cryptocurrencies that have strong backing and potential growth strategies.
Another key is strong volume. Liquidity is essential if you want to sell your position, so as not to cut into your returns.
The reality is that many cryptocurrencies have minimal volumes.
Diversify and Be Disciplined
One of the best ways to help reduce the risks of cryptocurrencies is diversification. That is, by having a wide assortment of investment classes in your portfolio — such as stocks, bonds, commodities, real estate, and so on — you will mitigate some of the overall volatility. As the old saying goes: “Don’t put all your eggs in one basket.”
Moreover, when it comes to cryptocurrencies, you do not have to have large positions. The reason is that the potential returns are significant.
And another helpful strategy is to use stop losses. This means your position will be automatically sold if it falls by a certain amount, say 15% to 20% or so. By doing this, you can often avoid massive losses.
Oh, and you can diversify with different cryptocurrencies. “Staying in the slowest-moving assets such as Bitcoin and Ethereum with the majority of the portfolio and looking for low-cap gems as though they were penny stocks is probably the smartest strategy,” said Fernando Martinho, who is the CEO at Nimbus Platform.
Since a cryptocurrency is a digital asset, you should be mindful of cyber security techniques. Here are some of the recommendations from Zhee:
- Always set up two-factor authentication with any cryptocurrency exchange. Use Google Authenticator when possible, otherwise, phone 2FA is the next best option.
- Handwrite your “private keys” and store this somewhere like a safe in your home. Think of this as your one and only golden key to access your cryptocurrency. Do not store this digitally in case your phone of computer is hacked.
- Do not share your private keys with anyone. The exception: Provide access to your private keys in your living will so that a family member can access your cryptocurrency.
- Do not leave your cryptocurrency on an exchange, especially a decentralized exchange.
- Unless you are trading daily, put your cryptocurrency onto a “cold storage” wallet like a Ledger Nano S. Then put that into your safe.
ETFs (Exchange-Traded Funds)
ETFs are shares you can buy on an exchange like the NYSE or Nasdaq. They allow you to own a basket of stocks or other assets, which are usually part of an index. This means you can easily get diversification in a certain category of the market. The fees are usually low as well.
So what about ETFs for cryptocurrencies? For now, because of regulatory issues, there are none available in the U.S. market.
However, there is still a way to get exposure. This is through the purchase of an ETF for blockchain stocks. Some to take a look at include First Trust Indxx Innovative Transaction & Process ETF (NASDAQ:LEGR), Reality Shares Nasdaq NexGen Economy ETF (NASDAQ:BLCN), Amplify Transformational Data Sharing ETF (NYSEARCA:BLOK) and Innovation Shares NextGen Protocol ETF (NYSEARCA:KOIN).
On the date of publication, Tom Taulli did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Tom Taulli (@ttaulli) is an advisor/board member for startups and author of various books and online courses about technology, including Artificial Intelligence Basics, The Robotic Process Automation Handbook and Learn Python Super Fast. He is also the founder of WebIPO, which was one of the first platforms for public offerings during the 1990s.