Investing,
July 25, 2020

How to Invest in Crypto Currencies: Risks and Better Options

Gregory Weiss
How to Invest in Crypto Currencies: Risks and Better Options

Recently there has been a great deal of interest in investing in crypto currencies such as Bitcoin, Bitcoin Cash, Bitcoin Gold, Ethereum, Ethereum Classic, Litecoin, Ripple, Dash, Iota, Monero, Neo,... Their high volatility, attempts at regulation,... generate great doubts about the future of these instruments but what is certain is that they also represent an opportunity to make profits that makes the crypto market today in everyone's mouth.

In this article we will analyze in depth how this market works, what are the main risks of investing in crypto currencies, how we can keep them under control, what are the best options we have available to invest in these instruments and the advantages and disadvantages of each of these options.

The initial idea of many people about crypto currencies was that this type of asset was going to be an alternative means of payment to the traditional one. The benefits of digital currencies were not to depend on any government, any central bank and any monetary authority. Investors saw these assets as an alternative to everyday money. Anonymous transactions and transactions outside the regulation of the system are the main characteristics of crypto currencies as a means of payment.

Another aspect that makes crypto currencies attractive is their scarcity. Without going any further, in the case of Bitcoin a total of 21 million will be put into circulation. Once this monetary mass is in the market, it will no longer be possible to create more Bitcoins, which would be equivalent, for example, to having mined all the gold that exists on the planet.

Being a scarce asset, the market gives it value, is the same principle that applies to gold and precious metals. Bitcoin has actually been compared to gold for several reasons. Among others we can mention:

  • It is scarce
  • Is immune to inflation
  • Acts as an active refuge

It's a value deposit (it's a currency, digital but a currency at the end of the day)

Even Germany in 2013 equated it with the yellow metal and it is known as gold 2.0.

Do these reasons justify its volatile highs and lows? The truth is that the psychology of investors, acting as a large mass and speculative positions also have a lot to do with this.

What can we say, financial markets work like this. When a market has attractive characteristics (or revaluation potential) all investors are launched en masse. This has happened with crypto currencies and will happen again in the future with other instruments. But, as a saying goes in the world of trading and investment:

Behind a boom there is a crash and behind a crash there is a boom.

In short, what goes up must go down and what goes down must then go up. Everything is a cycle of ups and downs. Long and short. Financial markets are almost always moved by expectations rather than facts.

What was the purpose of crypto currencies?

The first to see the light, of these assets that have reached more popularity, was the Bitcoin in 2009. The objective of this creation was neither more nor less than to design a payment system outside the traditional (banking).

In the face of the financial crisis, confidence in the payment system and the monetary authorities was lost, and they were harshly criticized for having created a bubble in the system.

Through Blockchain technology, which underpins all cryptomoney transactions, a mechanism for transferring funds without the need for a bank was made possible. Something unthinkable until the birth of this technology.

The puzzle was assembled, only one piece was missing; an asset that was beyond the control of governments. A currency that is not under the supervision of any central bank. In this way, independence was total. We are talking about a parallel system in which monetary decisions have no relevance. The market is the only one that dictates the rules.

Bitcoin, like the rest of this type of crypto currency, are nothing more than accounting entries in a digital book. That's right, the blockchain is nothing more than a digital ledger that can only be altered when the participants in the blockchain give the go-ahead.

The digital ledger is not susceptible to manipulation, accounting entries that give rise to transactions cannot be made unilaterally.

Sounds good, doesn't it? One might even think that this will be the means of payment of the future. Thus replacing the exchange of currencies (euros, dollars, pounds, yen, etc.) as these currencies replaced gold. But the question is not so simple, the invention has not come out, so far, as well as expected.

What has happened? In reality, crypto currencies also have their own risks, some of the technology they use and other risks that affect when investing in crypto currencies. This is the issue we are dealing with today. As Sun Tzu says: "We must know the enemy in order to face it". Let's get to it:

Risks of Investing in Crypto Currencies

1 - High volatility

Bitcoin (as a benchmark asset for this market) presented an annualized volatility in the last 12 months of over 80%. This high volatility makes these assets considered high risk and unsuitable for retail investment as expressed by the Security Exchange Commission (SEC).

Such volatility is ideal for trading operations. We just need to know how and with what:

We must opt for investment instruments that allow us to carry out active management to avoid the risks of fluctuations in the market. In other words, with agility to take long and short positions. As well as to enter and exit the market easily.

Volatility can become an ally rather than a risk. But beware, we must know how to handle volatility.

2 - Changes or attempts at regulation

The truth is that so far, except in very specific cases, there are only declarations of intent to regulate the crypto-money market.

There are opinions for all tastes: Those who think it is a big bubble that will burst sooner or later and for many others, this regulatory deficit is a benefit, it is what gives personality to this market and a large part of the attraction of these assets is the feeling of rebellion against the monetary system.

However, countries such as China have banned transactions with crypto currencies as fraudulent.

There are also those who think that the fact that they are not under the protection of any government, defines these assets as having no intrinsic value. Their valuation only comes from the price that investors give them in the market. The law of supply and demand is the only applicable law. If the market (as a collective entity) decides to withdraw confidence in crypto currencies, they will have no value.

In some ways none of the traditional currencies have intrinsic value. They are just trust. But being under the umbrella of a central bank and ultimately by the International Monetary Fund (IMF) makes traditional currencies more reliable assets. If for some reason confidence in any currency falters, the current central bank or the IMF would take steps to restore it. That is their function.

However, with crypto currencies it is the market that rules, it is the market alone that can determine their value. This should make us think if it is worth investing in crypto currencies for purposes other than trading, understanding trading as obtaining capital gains from the market in the short term.

There are several reasons to start regulating crypto currencies. Beginning with the problems they present in the protection of consumers and investors, given that these assets do not have the backing of any financial institution. The investor who buys virtual currencies in cash is completely helpless.

The additional risk is how the market will take over the regulation of crypto currencies. There are people who will not feel very good about this.

Does anyone think that in the face of so much control over money transactions (especially to prevent the financing of terrorism or money laundering) they are going to let transactions be carried out anonymously and without leaving a trace?

The regulation of this market can be implemented at any time and this can make crypto currencies unattractive. On the other hand, regulation is quite necessary because the mechanism of buying and keeping in a wallet is a highly insecure strategy, as we will see below.

The digital ledger is not susceptible to manipulation, accounting entries that give rise to transactions cannot be made unilaterally.

Sounds good, doesn't it? One might even think that this will be the means of payment of the future. Thus replacing the exchange of currencies (euros, dollars, pounds, yen, etc.) as these currencies replaced gold. But the question is not so simple, the invention has not come out, so far, as well as expected.

What has happened? In reality, crypto currencies also have their own risks, some of the technology they use and other risks that affect when investing in crypto currencies. This is the issue we are dealing with today. As Sun Tzu says: "We must know the enemy in order to face it". Let's get to it:

Recommendations

The main recommendations we can offer you to deal with the risks of trading with crypto currencies are:

  • Always use stop loss.
  • Use technical analysis indicators to help measure volatility (e.g. Bollinger Bands, ATR, etc.).
  • Use limited leverage to avoid that, together with volatility, our possible losses increase. Most online brokers already offer a much lower leverage to invest in crypto currencies than against other instruments such as Forex, stocks, ... due to this high volatility they have. Even so, don't get carried away by the one that offers you a higher leverage because it can be counterproductive.
  • Open small trades. Don't risk too high a percentage of the account for each trade.
  • Always have a trading plan and carry it out with discipline.

We hope this article has helped you to solve your doubts about how to invest in crypto currencies correctly. You should always know the risks of any instrument you are going to invest in and which are the different options to do so, choosing the best for you and your profile as an investor.

Send us your opinions or experiences from the comments section at the bottom of this page and you can also share this article on social networks and thus allow it to reach other people to whom it may be useful. Thank you.

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