For Bitcoin, Ethereum and other digital currencies, here’s how they work and how to open and stock a crypto wallet.
The best thing about cryptocurrency is also the worst thing about cryptocurrency: There are few rules. Digital currencies and the ledgers that hold the transactions offer much more freedom than government-backed currency but come with fewer protections. The inspiration for the whole system was avoiding bank fees and all the regulations that go along with organized financial institutions.
The flip side of that coin is that there are endless opportunities for new solutions and no limits on creativity. The brief history of Bitcoin and Ethereum show that taking a hard fork is always an option.
If you’ve not been paying attention to these virtual currencies based on cryptology and traded on blockchain, now’s a good time to get up to speed. These nine questions cover the basics of how to get started and how to avoid scams.
How can I get started as a cryptocurrency investor?
First, you’ll need an account on a cryptocurrency exchange. These platforms allow you to buy, sell and hold virtual currency. Coinbase is one of the most well-known platforms. The company was founded in 2012 and went public in April via direct listing as opposed to a more traditional IPO. Binance, Kraken and Gemini are other popular platforms. Some investment companies that offer traditional stock trading services also offer cryptocurrency options.
Payment apps Venmo and Cash App also allow customers to buy, sell and hold certain virtual currencies. Venmo customers can buy Bitcoin, Ethereum, Litecoin or Bitcoin Cash. Cash App deals in Bitcoin only.
Once you’ve selected a trading platform, you’ll need a wallet to store your virtual currency. Many exchanges offer wallets as part of their services. These are “hot” wallets because they are always connected to the internet. Your other choice is a “cold” wallet. Some investors prefer these offline physical storage devices. If you’re just getting started with your crypto investing, an online wallet is more convenient. If your portfolio grows significantly, you can use both options and store the majority of your coins offline while keeping some amount in an online wallet to make trading easier.
Public and private keys are another important part of crypto investing. People use your public key to send money while your private key unlocks your account. Your private key proves your identity and rights to the account. It can be in the form of a 256-bit binary code or a 64-digit hexadecimal code or a QR code. These keys are generated when you open a wallet for storing your currency. If you lose these keys, you lose your virtual currency.
Is there a minimum I need to invest?
It depends on the platform you choose and the coin you buy, but generally the initial investment is low if you are starting with fiat currency. You can buy a fraction of a coin, which makes getting started easier. Also, most exchanges charge fewer fees if you are using one form of cryptocurrency to buy another form.
Coinbase offers $5 in Bitcoin for signing up for an account and requires a $2 account minimum as well as transaction fees.
On Gemini, there is no account minimum and transaction fees range from .5% to 3.99%.
On Binance, there is a minimum trading amount of $10 as well as transaction fees that go from .1% to 5% of the purchase.
Venmo’s minimum purchase is $1.
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Some trading platforms also charge maker fees and taker fees, including Kraken and Coinbase Pro. These fees are designed to make high-frequency markets somewhat more stable. On the Coinbase Pro exchange, the fees are based on volume and range from .10% to .30%
Other typical costs involved include trading commissions paid to exchanges, the width of the bid-ask spread, and a fee to transfer funds to/from your bank account.
Where can I buy cryptocurrency?
Some traditional brokerages offer this option, such as Charles Schwab. There are also online only platforms that specialize in cryptocurrency only.
- Coinbase and Coinbase Pro
- Cash App
Initial coin offerings are a way to get in on the early days of a cryptocurrency. A virtual currency startup often offers a new coin as a way to raise money and publishes a related white paper that explains the parameters of the offering. These sales are usually unregulated and it helps to have a basic understanding of cryptocurrency before participating.
What are the different types of cryptocurrency?
Bitcoin is the most well-known virtual currency. Ethereum is a close second with Dogecoin in third, thanks to a few famous fans.
According to Yahoo Finance, the top 10 currencies by volume as of May 4 were:
What are the benefits of using cryptocurrency?
Even though cryptocurrency has been around since 2009, investing in digital currencies still feels like the early days of the internet when investing in the right company could make you a millionaire. Early investments in Bitcoin have been lucrative but other coins have either never taken off in value or risen quickly only to crash. Investing in cryptocurrency is an investment in the future of technology, particularly when it comes to solutions that use blockchain.
Cash transactions are down significantly, due in the short term to the COVID-19 pandemic, according to a 2020 global payments report from McKinsey. However, the report also found that banks have closed both branches and ATMs over the last year, which will push more people to online banking in the long run. Despite the uncertainty about how the recovery from the pandemic will roll out, the report states that one trend is clear: “The imperative to accelerate transformations to a digital-first and more agile organization has never been greater, and it exists globally.” Virtual currencies can be more agile than traditional currencies and so fits in with that trend.
Investing in cryptocurrency can give you more control over your investments and avoid banking fees.
What are the risks of using cryptocurrency?
All investments are risky whether you’re putting your money in a new business or a stock market fund or cryptocurrency. Cryptocurrencies have all the standard risks as well as the uncertainty of a new technology. Robinhood has an excellent description in its crypto disclosure:
“Trading in cryptocurrencies comes with significant risks, including volatile market price swings or flash crashes, market manipulation, and cybersecurity risks. In addition, cryptocurrency markets and exchanges are not regulated with the same controls or customer protections available in equity, option, futures, or foreign exchange investing.”
The Securities Investor Protection Corporation protects investors if a brokerage fails, up to $500,000. Cryptocurrencies don’t have that protection. Virtual currencies also fluctuate more dramatically than many investments. Ethereum is one of the most well-known virtual currencies. It has seen a dramatic fluctuation in value over the last few months. In September, the value was $357.33. As of May 4, the value was $3,393.33. That coin is going in the right direction for investors. The value of Litecoins, another popular coin, has been more volatile. The value has gone from $237.57 in December 2017 to $31.78 in January 2019 and now sits at $294.84 as of early May.
In addition to these macro risks, there is also a more mundane risk. If you lose the security key to your wallet, you lose access to the investment. If you keep your currency in a cold wallet and it gets stolen, you lose the investment. It might not be any good to a thief who doesn’t also have the key, but the value is still gone. If you hold your currency in an online wallet and the company managing the wallet gets hacked or shuts down, you lose the investment. Google “Quadriga” or “Mt. Gox” if you want a history lesson on some of the more scandalous elements of the cryptocurrency market.
The Motley Fool recommends investing in companies that are using blockchain as part of an overall business strategy. With that approach, you can benefit from early adopter gains without taking on quite so much risk.
How can I avoid scams?
Buyer beware because if a cryptocurrency sales pitch sounds too good to be true, it probably is. There is no Better Business Bureau for digital currency and no governing body that will listen to complaints about scammers. Many bad actors use the same techniques that scammers have used for years: The Ponzi scheme, requests for payment up front and job scams.
As Daniel Van Boom explained on CNET, alt-coins in the cryptocurrency world are like penny stocks in the traditional stock market and some grow 30, 40 or 50 times in value in the space of a few days. Scams are also common as bad actors fake testimonials and other promotional information to lure in buyers.
The Federal Trade Commission recommends looking for these red flags to spot scams:
- Guarantees that you’ll make money
- Promises of big payouts with guaranteed returns
- Promises of free money
- Big claims without details or explanations
Kaspersky also recommends watching out for fake websites and mobile apps, emails that promise a great deal on initial coin offerings and bots on social media.
What can I buy with cryptocurrency?
A Tesla, for starters, if you’re in the market for an electric car, have Bitcoin to spend and live in the US. Tesla bought $1.5 million in Bitcoin in February. The Swiss real estate company Bithome will sell you a house in Bitcoin.
Green Man Gaming, XBox and Playstation Network accept Bitcoin and you can use the digital currency to get VPN services as well from several companies including NordVPN, Surfshark, ExpressVPN, Cyberghost and ProtonVPN.
If you aren’t in the market for a big-ticket item, Overstock.com and Newegg accept Bitcoin. You can even use your cryptocurrency to buy gift cards from Bitrefill and Gyft to use at many large retailers.
You also can buy more cryptocurrency. Many exchanges prefer that purchases be made in digital coins and charge fees for transactions done in fiat currency.
It’s important to remember that there are no guarantees when it comes to making purchases with Bitcoin or other cryptocurrencies. Payments are typically final–no refunds–and some data about the transaction will be in the public ledger of the currency, depending on what coin you are using.
Can the IRS tax cryptocurrency?
The first question on the 1040 federal tax form for 2020 is about cryptocurrency: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” The IRS expects you to report any digital currency you owned in 2020, even if you didn’t complete any transactions with the funds, as CNBC explains.
In 2014, the IRS decided that cryptocurrency is property, not currency. That means you’ll pay taxes on any digital coins you own. NerdWallet explains that you will owe taxes on Bitcoin that you mine and possibly capital gains as well.