Crypto Investing – A New Investor’s Guide
Bitcoin concept on digital screen
By now everyone has heard of Bitcoin
Because Bitcoin started the industry, virtually every other crypto-asset is called one alt-coin. Altcoins can be categorized in several different ways.
Protocol Tokens
Protocol tokens, also referred to as Level-1 or base-layer tokens, are native to a blockchain and are necessary for the operation of a given platform. Bitcoin, for example, is a protocol token not only because it is what users send and receive over the network, but because it is also how miners (payment processors) are compensated for providing computing power.
Another protocol tokenEthereum
Ethereum works in a similar way to bitcoin, where miners use significant amounts of computing power to add transactions to the network.
That said, there are many other prominent blockchains with their own protocol tokens, with some of the largest Solana
Application Tokens
If the base layer of a blockchain is the operating system, decentralized applications (dapps) are the programs that run on top of them. Many of these applications have their own tokens (known as dapp tokens) which is also traded freely on many stock exchanges. Dapp tokens first rose to prominence in 2017 and 2018 during initial coin offerings (ICOs), when many founders raised millions – sometimes billions of dollars – through token sales to fund product development. It is worth noting that the vast majority of these ICO projects failed and the value of their assets went to zero, which was a reflection of the novelty, hyperbole and excitement in the space.
Nevertheless, today there are still dozens of dapp tokens with market capitalizations in the hundreds of millions or even billions of dollars underpinning applications with real utility and actual business operations that make money, headlined by decentralized finance (DeFi) tokens. Some of the most prominent include Compounded
DeFi is an umbrella term used to capture traditional financial applications (such as banking or lending) that are replicated on a blockchain through dapps and smart contracts, which are automatically executable pieces of code that are activated when certain conditions are met. Think of smart contracts as if/then statements embedded in blockchains. For example, you can place an order on a decentralized exchange to buy bitcoin if the price hits a certain point. Today, there is more than $270 billion locked up in blockchain applications and DeFi tokens.
Finally, it is important to highlight the latest developments in crypto, non-fungible tokens (NFT). A core component of money, or crypto, is that every asset should be valued equally by every investor. They must be fungible. NFTs are the exact opposite of this. While they operate on top of blockchains just like any protocol or dapp token, they have a set of unique properties or characteristics that make them unique. If bitcoin is the first iteration of scarce digital values, then NFTs are the natural successors.
Effort and passive income
For many investors, exposure to spot market prices has been risky and/or lucrative enough for their first foray into crypto. However, as the industry matures, we are starting to see ways for investors to earn passive income from their holdings. This strategy can help to fill up gains or hedge against price risk.
The top two strategies are staking and yield farming. I break each one down individually.
Staking
Staking is the act of posting certain crypto assets as collateral to participate in the operation of a blockchain. As compensation for locking holdings, users receive regular rewards in a manner similar to interest payments. Staking is useful for blockchains that operate a proof-of-stake (POS) consensus mechanism. This is a different approach than proof-of-work (POW), which is the computationally intensive and expensive mechanism used by bitcoin, litecoin, bitcoin cash and many other tangents to the original blockchain.
Although POW has proven to be very safe and effective in most cases, there are growing concerns about its energy use and associated carbon footprint. Additionally, POW blockchains have scalability and throughput issues (Bitcoin can only process a handful of transactions per second), while POS platforms can handle hundreds of thousands per second.
Prominent protocols that can be staked include Ethereum, Solana, Algorand, Cardano, Polkadot and Tezos
Please note that POS consensus mechanisms are not homogeneous and each blockchain network may use a different way of calculating stake rewards, taking into account various factors such as:
- Minimum stake requirement
- Lock-in periods
- Payment plans
- Reward amount
Yield farming
Apart from buying DeFi tokens, it is also possible to earn them through a process known as yield farming. Yield farming can be considered DeFi 2.0. Before, when you provided liquidity to a decentralized exchange or lending protocol, you simply earned a fee or earned interest. However, in 2020, Compound started a new trend that rewarded users with governance tokens, COMP in this case, as an incentive program.
In keeping with the space’s decentralized ethos, governance tokens are mechanisms for each protocol’s respective founders to relinquish control of the platform and transfer it to users. In turn, token holders can use their holdings for additional rewards or vote on governance decisions that vary between protocols.
COIN, crypto stocks and other crypto securities
When Coinbase went public in April 2021 with the largest direct listing in US history, many investors mistakenly believed it was their first opportunity to gain crypto exposure through brokerage accounts. However, there are many listed securities that have offered exposure to the crypto space for some time. There are too many to mention in one article, but there are two main categories to keep in mind.
Exchange-traded products
An ETP can be thought of as a wrapper around an asset or group of assets such as bitcoin and cryptocurrencies, which trade on an exchange like a security. Exchange-traded funds (ETFs) such as State Street’s
The largest ETP provider is Grayscale, whose bitcoin trust (GBTC) is by far the industry’s largest fund available to investors by AUM (assets under management) – USD 14 billion at the time of writing. That said, while GBTC has enjoyed a large premium attached to its stock for much of its existence, it has traded at a double-digit discount for more than a year. In fact, the discount is now higher than 40%. Grayscale offers similarly structured products that track other assets such as ether, litecoin, ethereum classic, solana and even some diversified indices.
But the crypto ETP market is far more than shades of gray. For example, Switzerland’s SIX Swiss Exchange has a robust list of crypto ETPs exceeding 40 tickers, with the largest by trading volume being WisdomTree Bitcoin (BTCW.SW) and 21Share Ethereum ETP (AETH.SW). Canada’s Toronto Stock Exchange launched North America’s first crypto ETFs in the first quarter of 2021: Purpose Bitcoin ETF (BTCC) — which got off to a very strong start, raising nearly $1 billion in its first month —Develop Bitcoin ETF (EBIT) and CI Galaxy Bitcoin ETF (BTCX).
In addition, the US’s first bitcoin ETFs were launched in October. However, they do not reflect the spot price of bitcoin, but futures contracts traded on platforms such as the Chicago Mercantile Exchange. The first to launch in October was the ProShares Bitcoin ETF (BITO). However, other offerings include the Valkyrie Bitcoin Strategy ETF (BTF) and the VanEck Bitcoin Strategy ETF (XBTF).
Bitcoin Proxy Shares
It is also worth mentioning some of the stocks that are seen as a proxy for bitcoin. Business analytics firm MicroStrategy
How to buy and hold crypto
Aside from making investment decisions, many of you will have questions about the specific mechanics of crypto investing. This is somewhat new to the industry because there are few options for buying crypto assets from traditional brokerage or wealth management accounts.
Fortunately, buying and selling crypto has never been easier. In the early days of bitcoin, buyers had to transfer money all over the world to unregulated exchanges with no guarantees of receiving bitcoins or refunds. Today, we have a wide variety of suppliers who have gone to great lengths to make their products easy to use.
For example, in the US alone there is a wide variety of secure and regulated exchanges that offer easy onboarding procedures for new customers. Some of the largest and most widely used include Coinbase, Kraken and Gemini. They each have websites and mobile applications that are easy to use.
Additionally, as the space has grown, many non-crypto native platforms and financial applications such as Square, Robinhood, Revolut and PayPal have enabled crypto trading. The added benefit of these platforms is that you don’t need to do any additional onboarding if you’re already a customer of theirs.
Once you buy crypto, you need to keep it safe. Virtually all regulated platforms recommended for first-time buyers will provide software wallets (similar to mobile banking applications) that are reasonably secure. You can trust that they are built by experienced software developers and security experts. The security of these applications can be further improved by taking a few basic steps:
- Choose a complex and unique password or passphrase
- Using two-factor authentication (2FA) as a second check when logging into your account.
For institutions, there is also a growing array of OTC desks, prime brokers and service providers such as Fidelity that can support the individual trading, security and reporting needs of these buyers.
Finally, here are some important questions to ask yourself when getting ready to buy crypto:
- Why would I want to buy crypto?
- How long do I plan to hold my crypto?
- What types of cryptoassets do I want to buy?
- How much crypto do I want to buy?
- Do I ever plan to borrow against my crypto?
- Am I interested in earning passive income from my holdings, such as interest or wagering fees?
- How much responsibility will I take for the security of my krypton?
