Even with the current pullback in cryptocurrency prices, many people are interested in getting involved. Investing in crypto can be profitable, but before you jump in, there are a few things to understand.
5 Things to Know about Investing in Crypto
Before you get started investing in crypto, take a step back and consider whether it belongs in your portfolio.
1. Cryptocurrencies are Speculative
Crypto is a speculative asset class. It’s new, and it’s hard to tell whether it will truly reach critical mass. Blockchain technology, which underpins crypto, could be the next approach to tech infrastructure. Or it could bomb. We don’t know yet whether crypto will have staying power.
If you want to add it to your investment portfolio, limit your exposure. Many experts recommend that you keep speculative assets — like crypto — to 5% to 10% of your portfolio.
2. Crypto is More Correlated to Other Assets Than You Think
One of the big assertions by crypto enthusiasts is that crypto isn’t correlated to stocks. However, the data tells a different story. Cryptocurrencies show a remarkable correlation to the stock market.
While there’s potential for growth, expecting crypto to act as a hedge against stocks might not work. I keep crypto in my portfolio, but I don’t expect it to move opposite to stocks.
It can add diversity to your portfolio but don’t expect it to be a hedge.
3. Market Manipulation is a Big Part of Crypto
Decentralization is a big part of the crypto ethos and mythos. However, you might be surprised at how a few “whales” control a lot of what happens in the cryptocurrency market.
All you have to do is look at what happens to different coins when Elon Musk hypes them. Influences have been paid to pump altcoins — only to dump them later. There are plenty of scams with crypto, and price manipulation is relatively easy.
This doesn’t mean that you should never invest in crypto. Instead, it means you should go in with your eyes open and be aware that an influencer could tank the price at any moment. Whales could dump their holdings for profits at any time and leave you holding the bag.
4. Memecoins Probably Won’t Make You Rich
There are stories of people who became millionaires — on paper — due to the meteoric rise of memecoins like Dogecoin. However, after the price tanked following Elon Musk’s SNL performance, these folks haven’t recovered that status.
When choosing cryptocurrencies for investment, it’s important to look at the use case. Lots of hype isn’t a use case. Look for cryptocurrencies that have some sort of staying power and solve a specific problem.
One of the reasons Ethereum is so popular is due to the fact that you can build on the chain. There are apps and a lot of the decentralized finance infrastructure is built using Ethereum or Ethereum derivatives.
Don’t assume that you’re going to get rich quickly with memecoins. There’s a good chance you could end up the victim of a scam. Or just lose out when the hype runs its course.
5. The Regulatory Environment Could Change Everything
The case involving Ripple is still wending its way through the courts, with the Securities and Exchange Commission (and others) trying to figure out how to classify cryptocurrencies.
We don’t know what the result will be if some crypto assets are treated like securities while others are seen as currencies or commodities or something else.
These issues will eventually impact taxation. Additionally, you should understand that crypto assets aren’t covered by SIPC insurance. So, if a cryptocurrency exchange fails, your money isn’t protected.
Coinbase and Crypto.com appear to be in some trouble, so if you keep a lot of crypto on those exchanges, you could lose money if they do fail. (They might not fail, though. We’ll see if they make it through this crypto winter.)
Finally, keep an eye on countries issuing their own digital currencies. If you could use a digital dollar, it might destroy the case for other cryptocurrencies and blockchain projects.
Bottom Line
Cryptocurrencies and other digital assets have the potential to offer an addition to your portfolio. However, realize that these are speculative assets. We don’t know if blockchain technology really will be the next big thing.
Once you have other goals squared away — such as using a tax-advantaged retirement account to save for retirement — you can consider speculating with cryptocurrencies. Just be careful. Understand the digital assets you choose. And know why you’re investing in cryptocurrency and where it fits into your strategy before moving forward.