How to Responsibly Build Wealth with Cryptocurrency

Knowledge

New investors are often advised against investing in financial products they do not understand, and this advice is given for good reason. Ill-informed, emotionally driven financial decisions to invest in a financial product you do not fully understand can hinder progress toward your financial goals. Rather than getting swept up in hype surrounding a particular cryptocurrency or the idea of cryptocurrency investing in general, take time to understand what cryptocurrency is—and its benefits and risks—before investing. 

What is Cryptocurrency?

Cryptocurrency is a decentralized form of digital money that can be used to make online purchases or held as an investment in the hope that it becomes more valuable over time. Some of the most well-known cryptocurrencies are Bitcoin, Ethereum, Dogecoin, and Tether, but it is an emerging market with thousands of unique cryptocurrencies and millions of users across the globe. Transactions and exchanges using cryptocurrencies are typically facilitated with blockchain technology, which transparently records and tracks assets within a business network. Blockchain technology is thought to reduce or even eliminate the need for a third party, such as a bank, to mediate online transactions. As such, no centralized authority governs the creation and exchange of cryptocurrencies, prompting many to think of cryptocurrency as the “Wild West” of finance—a lawless environment with high risks and high potential rewards. There are several approaches to investing in cryptocurrency, some of the most common of which are purchasing units of an individual cryptocurrency directly through an exchange, investing in companies with a stake in cryptocurrencies, or investing in exchange-traded funds that focus on cryptocurrencies through a brokerage account. 

Benefits of Cryptocurrency

Investing in cryptocurrency is increasingly seen as a way to support and engage with cutting-edge financial technologies. Demand for cryptocurrencies has increased over time, meaning that although it is still an emerging and volatile market, there is potential for dramatic and lucrative spikes in value. Additionally, cryptocurrency has been found to facilitate more efficient, low-cost transactions across national borders than traditional financing systems allow, which can benefit those who regularly do business internationally. Another benefit of cryptocurrency is the public and transparent nature of blockchain technology, which offers protection from fraud. The decentralized nature of cryptocurrency can be attractive to those who prefer low government oversight in their finances or who wish to divest from current economic structures. 

Risks of Cryptocurrency

Many of the benefits of cryptocurrency also inherently pose significant risks. The same volatility that allows for substantial increases in value allows for significant losses. It is impossible to infallibly predict the future of any investment, so trying to time the market to maximize value is not a sustainable or practical long-term trading strategy. Additionally, the current low regulation of cryptocurrency markets increases regulatory uncertainty as governments around the world are still determining the best ways to implement oversight that will regulate the market’s future operations. Unlike traditional currencies, consumers cannot reliably pay for daily expenses such as day care, food, or other costs of living with cryptocurrency. Cryptocurrency is a speculative asset, meaning that a unit of cryptocurrency does not hold inherent value. Instead, it relies on people’s perception of its value, making cryptocurrencies susceptible to market manipulation. 

Strategy

The first step in your venture into cryptocurrency should be making sure that you understand the risks and benefits of investing in it. Once you have done your due diligence by researching the specifics of the currency or currencies you would like to invest in, your next step should be to create a strategic investment plan. This plan will guide your investment decisions moving forward. Thinking deeply about your strategy (when you will invest, what you will invest in, where you will invest, how much you will invest, and the circumstances in which you would sell your investments) before you begin investing will help you make more rational decisions when faced with market volatility. 

Define Your Goals

Before making any investment decisions, it’s wise to establish what you want to get out of the experience. Are you prioritizing short-term profits, or do you prefer a long-term approach to building wealth? Do you intend to hold cryptocurrency exclusively as an investment, or will you also use cryptocurrency to pay for purchases in your daily life? Do you want to diversify your asset allocation by investing in numerous cryptocurrencies, or are you only interested in one or two of them? Determining which aspects of cryptocurrency interest you and what you want to achieve with it will set the stage for you to develop a strategy to help you reach your goals. 

Manage Risk

In addition to goals, it’s essential to understand your risk tolerance before investing in cryptocurrency and create a game plan for if, how, and when you will divest. Having a plan before you need one offers a sense of security and allows you to act decisively with less fear and anxiety. As with any highly speculative market, it is important to limit your investments in cryptocurrencies to only funds you can comfortably lose without compromising your financial well-being. Some investors choose to make cryptocurrency a nominal portion (around 5%) of their overall portfolio, while others keep cryptocurrency investments separate from their long-term investment strategy and only invest money they would otherwise use for nonessential spending. Some investors also use stop-loss orders or strategies such as dollar-cost averaging to manage their risk while investing in cryptocurrency.