Cryptocurrency is easily among the most exciting investment opportunities to emerge in the past decade and beyond, but that doesn't mean that you can just throw some money at it and expect to profit.
Like any other investment, it is necessary to do your homework to maximize your return.
Asking the following six questions will help ensure that you have the knowledge required to capitalize on crypto's explosive potential.
1. Do you understand the basics?
Blockchain technology is the foundation of most cryptos.
A public ledger that automatically records every transaction seems simple enough but may trip you up with the finer points.
For example, every transaction has three components:
- and amount.
The input is the address the crypto initially came from, not where it is now. That means that if Rob sends Alexander Bitcoin, the input is not Rob's Bitcoin wallet but whichever wallet(s) gave Rob the funds he is now transferring.
The output would be Alexander's wallet, and the amount is how many Bitcoin were transferred.
To verify each transaction, a mining process in which computers use complicated algorithms to make sure they all "agree" with the previous blocks, or transactions, on the blockchain.
This verification makes crypto hard to steal or forge, as all coins are individually traceable to their origin point. You need to master basic concepts like these before becoming a serious crypto investor.
2. How much risk can you handle?
Like any other investor, the crypto investor must determine how much money they can potentially risk before purchasing any cryptocurrencies.
You must never risk more than you can afford to lose, especially since digital currencies may be rendered obsolete or worthless at a moment's notice.
It's also important to consider how much you want to gamble.
A brand new ICO, or initial coin offering, is likely to offer more profit potential than an established coin such as Ethereum, but it's also more likely to bust completely.
The proper investment for you must conform to your risk tolerance.
3. What ROI are you seeking?
You should make all investments with a clear exit strategy in mind. That means that if you purchased Litecoin with the intent to sell it for a 15 percent return, you should do so whenever the opportunity presents itself.
A news article, blog post, or TV expert should not be able to sway you from your initial plan.
In fact, it is often best to ignore the opinions of any experts attempting to influence your crypto decisions. Many of them purchase cheap tokens and then hype them up, artificially driving up their price to the expert's benefit.
Anybody caught in the tidal wave is likely to lose money, so do your research on trustworthy websites such as CoinMarketCap.com instead of relying on other people.
4. What's under the hood of your coins?
Many blockchain technology companies issue cryptos hoping to take off, making their coins similar to the stock market in that you are betting on the company's prospects.
For instance, ICX is a cryptocurrency issued by ICON, a tech company trying to create a blockchain that allows other blockchains to interact with each other without compromising their autonomy.
If the company succeeds in even a small manner (say facilitating insurance payments to hospitals in the company's native South Korea), the billions of dollars worth of ICX transactions will cause a massive price jump.
Many different coins have grand visions like this, and the truth is that most of them will never become what they claim to be.
Returning to the example above, ICON already has deals in place with a variety of hospitals, colleges, insurance companies, and banks to use their blockchain network. That's probably a point in their favor. However, the company is allowing the use of other cryptos within individual member communities, requiring ICX only when different blockchains interact with each other.
That means that the business could succeed without a corresponding ICX price spike. Be sure to understand how realistic any coin's prospects are before you back it.
5. How does available supply impact price?
Most crypto tokens have a limited supply that will never increase, enabling relatively scarce tokens to command a higher price per coin than those with more significant circulation.
For example, Bitcoin will only ever release 21 million BTC into the marketplace. This distribution will happen over time, with a small amount of brand new BTC added to the available supply as a reward for miners who verify Bitcoin transactions.
By contrast, Ripple (traded as XRP) plans a circulating supply of 100 billion XRP, and nearly all of it is already available. Sites such as CoinMarketCap display cryptos based on market capitalization, or the total value of a coin's circulating supply.
XRP will always fare well in this metric because even a few pennies multiplied by 100 billion available XRP will yield a lot of money. Backers cite the massive supply as a necessity to establish an accepted currency, but its potential may be compromised from an investor's standpoint as a result.
If a coin's final circulating supply remains unknown, uncertainty ensues.
For example, ICON reserves the right to release as much as 20 percent more ICX per year as a result of meetings with representatives from its constituent communities.
That presents prospective investors with the risk of severe inflation to balance against the upside of ICON as a technology company.
6. Which wallet is right for you?
Once you decide on a coin to invest in, you need to select a digital wallet in which to store your cryptocurrency.
Coinbase offers the advantages of an intuitive interface and convenient payment options, but it deals with only the most established coins (Bitcoin, Litecoin, Ethereum, Bitcoin Cash and others). If your investment is primarily speculative, Coinbase is not for you.
Other exchanges such as Kraken offer a better selection of coins but may introduce additional fees or a clunky interface relative to a more streamlined option.
It is possible that the right answer is to maintain multiple crypto wallets for your various investments, but you should always consider what type of wallet your prospective investment demands before making it.
Once you have answered the six questions above, you should be ready to enter the exciting crypto market.