Cryptocurrency transactions reached $1 trillion in August 2021. Last time we noted that digital currencies are traded by 13% of Americans, and the share of cryptocurrency owners among young investors is even higher (e.g., 51% in the UK). Professional fund managers also plan to invest in this instrument (98% of investment fund directors surveyed by Intertrust Group).
Investments in shares and cryptocurrency: what is the difference?
There is an opinion that investing in cryptocurrency is not more complicated and risky than buying shares. This is a fundamentally wrong approach, based on a misunderstanding of how both work.
Even shares of small companies, included, for example, in the Russell 2000 Index, which are considered high-risk assets, behave over the long term much more stable than the rate of the two most popular cryptocurrencies – Bitcoin, Ethereum.
Shares entitle their owner to a part of the company, a part of the business, which in most cases generates some kind of revenue. Having a bitcoin in an electronic wallet does not entitle the holder to anything, it is simply an entry in a distributed ledger.
There are two key factors that affect the movement of stock quotes:
- Changes in EPS (earnings per share). For example, if a company’s earnings grow better than expected, it has launched a new product, increased market share, i.e. something has fundamentally changed in the business, the stock is overvalued by the market and rises in value. The reverse is also true: profits fall and there are more competitors – quotations go down.
- Changing and revising multiples. This is a derivative of demand for a particular asset class. Even if a company’s business is deteriorating or does not show any clear growth drivers, the shares may still grow because this is the general trend on the stock market. Or a haip has formed around a certain company, as in the case of notorious memstocks. The price of securities may fall, even if fundamentally all is well in the company. It happens with shares of second-tier companies, when a mass investor moves funds from more risky assets to less risky ones on expectations of correction.
The market determines for itself the norms for the major multiples. For example, at a time when yields on deposits and bonds were high, given that it was a relatively safe investment option, multiples on stocks were low. A P/E (price/earnings) ratio of 10 (meaning you can get your investment back in 10 years) meant it was an expensive company. Today, for companies on the S&P 500 list, this ratio exceeds 20. In simple terms, interest in riskier assets, stocks, has become much higher. After all, you can earn almost nothing on deposits and bonds.
What does the rise or fall of cryptocurrencies depend on
Cryptocurrencies have nothing like that. There is no fundamental value, they are not tied to any real assets. The currency rises when there is demand for it, more people buy it, and falls when there is more or less a mass exit from it. It is essentially the simplest pyramid scheme.
Cryptocurrency prices can be seriously moved by public statements of influential media people or experts in this market, which shows the high volatility of these assets.
Cryptocurrencies are very sensitive to good and bad news. Malfunctions in the bitcoin application in faraway El Salvador, which was the first state to recognize BTC as an official means of payment, instantly collapsed the exchange rate by 10%. Linking cryptocurrencies to real things and expanding the range of goods that can be purchased with them gives digital money resilience. But in the future, the contribution of this factor is likely to decrease. Market participants are trying to make this instrument as transparent as possible, understandable to the mass investor, legalizing platforms, reducing the level of anonymity, going to the classical exchanges.
In regressive currencies, as in the case of bitcoin, there is a limit of total coins for mining – 21 million (that is, bitcoins have a limited supply, as in the case of gold). Now 18.8 million have already been mined. At some point, the mathematical formula will require infinite computing power to create one BTC. In theory, when approaching the limit, the value of the currency should rise. After all, supply will become limited and demand will remain. Other currencies practice burning “surplus” coins to stabilize the rate.
How to invest in cryptocurrency
You can get cryptocurrency in several ways:
- Mining, when you provide your computing power to solve the mathematical problem of creating a new block in the blockchain. Theoretically, you can also mine coins on an Android smartphone through special applications, but the profits there are paltry, the developers earn on advertising.
- Referral programs of crypto-exchanges, when its partners pay for attracting new users. This can be a commission from the transactions of customers who have clicked on the link you posted.
- ICOs and IEOs – launching new cryptocurrency projects. ICOs peaked in popularity a few years ago, mostly this investment option is remembered for epic failures, scams and large losses. IEO is a less risky option, the sale of tokens is carried out through a cryptocurrency exchange, projects are selected and listed.
A simpler option is buying and selling cryptocurrency through an exchanger or cryptocurrency exchange. In the first option, as a rule, the rate is higher due to additional commissions (in fact, it is an intermediary), more vulnerability to hacker attacks, but there is no need to be registered.
As in the case with other assets, the investor can choose a speculative trading strategy (trading) and try to profit from the differences in rates or hold on a long term (hold). The latter involves choosing a good time to buy a currency when the exchange rate has noticeably fallen and counting on the project to gain popularity over time and attract new users.
The same basic investment rules apply to cryptocurrencies: diversification (you shouldn’t bet only on a cryptocurrency, especially a specific one), finding a reasonable balance between risk and return, choosing a strategy depending on experience and skills. It is better to start trading cryptocurrency with a practice account to understand how everything works.
The cryptocurrency market also has its own “blue chip” currencies with high capitalization. They are more reliable, but they also have limited upside potential. There are the riskier smaller companies. They are the ones who are usually rated “What cryptocurrency should be invested in right now”. You should not trust them unconditionally, this list usually means that the author of the article has already invested in them and wants to attract new users. The most risky, speculative way, promising hundreds and thousands of percent, is to enter an ICO or IEO.
Top 10 cryptocurrencies by capitalization (data is current as of August 2021).
- Bitcoin (BTC). Market capitalization – over $856 billion.
- Ethereum (ETH). Market capitalization – over $357 billion.
- Binance Coin (BNB). Market capitalization – over $70 billion.
- Cardano (ADA). Market capitalization – over $69 billion.
- Tether (USDT). Market capitalization – $64 billion.
- XRP (XRP). Market capitalization – 52 billion dollars.
- Dogecoin (DOGE). Market capitalization – more than 40 billion dollars.
- Polkadot (DOT). Market capitalization – 25 billion dollars.
- USD Coin (USDC). Market capitalization – $23 billion.
- Solana (SOL). Market capitalization – more than 20 billion dollars.
How to invest in crypto on regular exchanges
- If an investor is interested in cryptocurrencies as an investment vehicle and does not risk buying them directly or mining them yet, it is possible to enter them indirectly through conventional exchanges. There are several options:
- Bitcoin and ether futures appeared in 2021. Futures replace physical contracts; they are a guarantee to buy an asset at a specific time, in an agreed amount and at a set price. For experienced investors, they allow them to hedge risks and speculate on the future price of an asset. For beginners, the futures are quite a complicated tool, especially in crypto with its frequent corrective price fluctuations.
- Shares of public companies, whose business is connected with cryptocurrency, presented on the stock market. Such examples are still few and far between. This is the cryptocurrency exchange Coinbase, and several other companies are preparing for an IPO.
- Shares of companies, where cryptocurrency makes a significant contribution to the capitalization. An example is software developer MicroStrategy, the largest bitcoin holder among public companies. Tesla also owns cryptocurrency, but it is a paltry contribution to its capitalization.
You can really try to make money on cryptocurrencies, find some strategies, include them in the risky part of your investment portfolio. Buying and selling digital currencies is no longer just a casino game. But everything here is still quite shaky. In addition to purely financial risks, the investor bears additional risks associated with the lack of state regulation and, consequently, legal protection.