Investing In Cryptocurrencies - The Ultimate Guide

So, you’ve decided to get exposure to cryptocurrencies. In this newer space, a personal financial advisor may not be of great help. Neither will your banker, unless you are a customer of a limited number of progressive Swiss private banks, which facilitate crypto trading. What now? This article provides practical information and resources around passive vs. active cryptocurrency investing, how to buy, sell, store, and monitor cryptocurrencies, as well as tax regulations in the space.

Introduction

So, you’ve decided to get exposure to cryptocurrencies. Perhaps you are seeking a geopolitical hedge against political and economic uncertainty, or perhaps you’re excited by the buzz and want in. What now? In this newer space, a personal financial advisor may not be of great help. Neither will be your banker, unless you are a customer of progressive Swiss private banks like Falcon or Swissquote, which facilitate crypto trading. This article provides practical information and resources around passive vs. active cryptocurrency investing, how to buy, sell, store, and monitor cryptocurrencies, as well as tax regulations in the space. As a private investor in cryptocurrencies, partner of cryptocurrency hedge fund Q2Q Capital, and overall cryptocurrency enthusiast, I’m excited to see how the space progresses and how acquisition will become ever-easier.

A quick caveat: This article will not cover deciding whether to invest in cryptocurrencies and how large the portfolio allocation should be. However, in deliberation, you should consider everything from your age, wealth, risk tolerance, and exposure to other asset classes to your level of conviction in various cryptocurrencies. You’ll need to read white papers as well as browse relevant materials on online forums and social media like Twitter, Reddit, Medium, and cryptocurrencies’ GitHub accounts. You’ll also need to determine the type of exposure you want. After all, virtually everyone is familiar with Bitcoin (BTC), but most do not know that there are well over a thousand cryptocurrencies—1384 as I write this.

Passive vs. Active Investing in Cryptocurrencies

I find it useful to think of cryptocurrencies as a new asset class, which allows us to compare their investment approaches to more established asset classes, such as equity investments. For example, one of the biggest topics of discussion in the equity investment space involves the merits of passive vs. active investing. The debate between the two approaches and their relative merits and risks is enough to create a dissertation and is beyond the scope of this article. However, generally speaking, passive investing is aimed at the longer term, requiring a “buy-and-hold” mentality, while active investing is more hands-on.

For example, in the context of equity investing, you’d need to decide whether to buy a broadly-exposed fund like an S&P 500 index fund or an actively managed fund where the fund manager engages in stockpicking. Alternatively, you could actively manage the portfolio yourself by doing your own stockpicking and monitoring. The same approaches exist in the cryptocurrency space, though many products are more nascent and in development.

Active Investing

Buying
Exchanges

By far the most popular way to trade cryptocurrencies is via a cryptocurrency exchange. Cryptocurrency exchanges are websites where individuals can buy, sell, or exchange cryptocurrencies for other digital currency or traditional paper (“fiat”) currency. Most exchanges convert cryptocurrencies into other cryptocurrencies; that is, you can use one cryptocurrency to buy another, but you cannot use your fiat money (like US Dollars). Some of the largest exchanges include Poloniex, Bitfinex, Kraken, and GDAX, which trade more than $100 million (equivalent) per day.

Still, some exchanges accept fiat money, where you would fund your account by wire transfer. Some exchanges even allow credit card purchasing of crypto, although usually in limited amounts and at high fees (e.g., 3.99% at Coinbase, the largest US-based exchange). The exchanges that accept fiat are typically limited to only a few prominent cryptocurrencies (e.g., Bitcoin, Bitcoin Cash, Ether, and Litecoin), which you can then in turn use to purchase other, lesser-known cryptocurrencies. You can refer to this site to research which exchanges are accessible from a specific country or accepts specific payment methods.

Exchanges also differ in important aspects. For one, the Know-Your-Client (KYC) guidelines whereby exchanges require certain information about the user may be more or less extensive. However, most exchanges nowadays—and certainly the ones dealing with fiat money—require user identification and proof of residence. Additionally, fees differ by exchange, but often range of 0 – 0.5%. Some exchanges also offer value-added features, such as Coinbase’s Vault, which stores coins you are not trading in the short-term in what they claim to be a more secure manner. Lastly, some user interfaces are “cleaner” while others are “busier,” though this is a matter of personal preference.

Cryptocurrency Storage and Monitoring

Storage

Perhaps unsurprisingly, security is of utmost importance when it comes to cryptocurrencies. You’ve likely heard of cryptocurrency thefts, such as the one at crypto exchange Mt. Gox, where $4 billion of BTC was laundered. If you are trading a lot, you may have to run the risk and leave your cryptocurrencies “on exchange,” where they are more vulnerable. However, if you are even a slightly longer-term holder, the safer way to store cryptocurrencies is “cold storage” where the all-important private keys, which provide control of the cryptocurrency, are stored in some offline way. This includes writing down private keys on a piece of paper, storing them on a hardware device such as Trezor or Ledger, or using a cold storage company such as Xapo or Swiss Crypto Vault (which store your BTC private keys in Swiss bunkers). For either type of storage, you typically simply send your coins to the public address of your storage. Once you need your coins, you can send them to wherever you need them, like an exchange account.

The trade-off here is between liquidity and security because you may need hours (check exact time with your cold storage provider) to get your coins out of more secure storage, which can be an eternity in crypto trading time. So, the decision around how much of your crypto portfolio goes into what kind of storage depends in part on your propensity to trade and your view of imminent market movements. Still, security and storage should be key items on your crypto to-do list.

Monitoring

Just as investing in another asset class, you should monitor your investment, even if you are a long-term holder. This includes tracking price information on sites such as coinmarketcap.com. Personally, I also like the mobile app Blockfolio, which allows you to input your crypto portfolio and track its value in real time.

Tax Treatment and Regulations

Few would argue that tax regulations have fully caught up to the rapid development of the cryptocurrency space. In the US, the accounting treatment of cryptocurrencies still seems uncertain since there hasn’t been official guidance from The American Institute of CPAs (AICPA) or the International Finance Reporting Standards (IFRS). In 2014, the IRS Revenue Ruling 2014-21 dictated that cryptocurrencies should be treated as personal property, with gains or losses on purchases or sales. Therefore, capital gains or losses should be recorded as if it were an exchange involving property, and if utilized as payment, it should be treated as currency but must first be converted to its fair market value. Still, the ruling left many questions unanswered. And, even within the US, states are treating cryptocurrencies differently. Consider New York State, which remains wary and has created the BitLicense system, which imposes guidelines on crypto companies conducting business with New York residents. In contrast, Vermont and Arizona have both recognized smart contracts and have assigned legal standing to records tied to blockchain, the underlying technology of all cryptocurrencies.

Given the evolving nature of the industry, it’s prudent to take a conservative approach by keeping all relevant documents, proactively discussing the subject with your tax advisor, and possibly even proactively approaching the authorities. After all, cryptocurrencies are garnering increasing attention from the SEC and the IRS. In November 2017, a court ruled that Coinbase must supply the IRS with identifying information on users conducting more than $20,000 in annual transactions.

Go Forth and Discover

This is undeniably a lot to digest. However, if you are an equity investor, there surely was a time when you hardly knew anything about the markets. Perhaps you timidly opened your first brokerage account, bought your first mutual fund, then your first individual stocks, international stocks, and perhaps eventually graduated to options and futures.

Is it worth it? I am a biased person to ask. And I admit that there is a steeper learning curve, but you are also entering a new asset class at an early stage, possibly providing you with opportunities harder to find in the relatively efficient world of established asset classes. For the record, I do not advocate substituting all other asset classes with crypto—merely that crypto should also be considered, though you should remain aware of its risk. If you are curious and decide to move forward with crypto investing, then you may want to start slowly and simply. I personally started by putting an amount of money that I was comfortable losing completely into one of the established exchanges, bought a little of the mainstream cryptocurrencies, and soon started to get a feel of whether this was for me. The best way forward for you will depend, of course, on your specific circumstances and preferences and may well include not investing in crypto at all. Just do not simply ignore the space and discard it out of hand without doing a little research for yourself. Good luck.