Unless you have been living under an “investing” rock, it is clear that all things Cryptocurrency (Crypto) are in vogue. And despite trying to be a long term “smart” investor it is hard to ignore the buzz and massive gains – sometimes daily – being seen with various Cryptocurrencies like Bitcoin, Ethereum or the latest “in” digital coin.
You can buy most of these through brokers like Robinhood or Coinbase, so that part has become easier, but like any sensible investment you need to do your homework (at least a little) before putting some money in. Otherwise its just a speculative gamble and for most, a sure way to lose money in the longer term. Here are 5 factors to consider before jumping into your digital crypto investing journey:
What is Cryptocurrency? These are digital currencies or coins “mined” (created) via solving complex algorithms that require significant computing processing power. Built on blockchain technology, these crypto coins are validated across decentralized systems across their world meaning not beholden to any government, central bank or agency.
Research what the Cryptocurrency is and how much (supply) is available
I know many people just follow the herd or what they see on social media around the next hot Cryptocurrency. And while knowing where the momentum is can be important you should take the time to do your own research to understand how the digital currency you are interested in is mined/sourced.
Don’t just read social media but instead go to reputable news sources to find out who is behind the digital currency, when it was started and how many “coins” are out there. For example Dogecoin can be mined to infinity whereas Bitcoin has an algorithmic limit of 21 million coins (of which 88% are mined).
In the longer term it is likely then (due to basic supply and demand laws) that the Cryptocurrency with limited supply will rise in price as demand rises, whereas the coin that has an unlimited supply is supplanted when the next shiny coin becomes the next trending digital currency.
Get Social and the Trend is your friend
By its nature Cryptocurrency lives in the great big online digital world and so it is followed and talked about actively on most social media sites (Reddit, Twitter, etc).
So if you are serious about investing in Crypto you also need to be serious about tracking the information flow and not just what you hear from your “friend” about their moon shot gain. In a lot of cases the next “big” coin is one that has the most online buzz so you need to be aware and actively tracking what the news flow is to try and get in early and exit before its too late.
Theoretically anyone can start their own crypto currency, and there are thousands out there, but like any currency it must be perceived to have value – to have value! Of late this upward spiral in perceived value has mainly fueled by the rise of social media and influencers who invest early. Nefariously some say Crypto currency is just a pump and dump scheme or an online pyramid scheme that relies on getting in early and continually up selling to others to push prices up. Or simply put Crypto is like digital metals – with the most valuable/established like Bitcoin being the Gold standard.
Can you afford to lose your entire investment?
What goes up, must come down. And Crypto is no different. You can see 500% gains in a week and then 200% losses the next (and remember an asset needs to rise a lot more to recover lost gains). In some cases the Cryptocurrency can also go back to zero as seen with many digital coins that have had their 15 mins of fame.
While the lure of a Cryptocurrency going from 0.01c to $1 (a 1000% gain) is hard to resist; be prepared for it to go back to 0.01c just as quickly. Which if you got in late (e.g at 0.15c) will sting quite a bit. So if you are new to Crypto, start small and diversify across a few coins. I started with $500 and bought 3 types of coins. So far so good, but if I lose it all, I can live with it and take the capital loss.
At what point should you sell if you see meaningful gains
So your Crypto coin has risen by 500% – now what? To avoid this have a stepped down exit strategy. The first step is to recoup your initial investment if the coin rises 5x to 10x its value. Then as it rises further, and you are now playing with house money, start looking to take out some more gains – to potentially invest in other coins.
There is no need to take it all out – after all we all have #FOMO (fear of missing out) – so keep some in as no one can predict the top and most Cryptocurrency is highly volatile. Just don’t take the #YOLO (you only live once) attitude and just let it all ride forever without an exit plan.
While this makes for great social media content and meme’s it is likely a doomed strategy, because while we all live once we tend to live for more than one moment in time.
Taxes – The Tax Man Cometh
Death and Taxes. Two things one cannot avoid in today’s world. As with any investment the government and IRS have cracked down on Crypto and the latest 1040 IRS tax filing form there is a specific question around Cryptocurrency investments and you have to report capital gains if you sell your coins.
The tax treatment of Crypto is a whole article on it’s own but just be aware you need to track and manage your cost basis and coins so you can legally report what you need to.
According to IRS Notice 2014-21, the IRS considers cryptocurrency to be property and not a virtual currency. As a result capital gains and losses need to be reported on Schedule D and Form 8949 if you made a net gain.
Gains from mining cryptocurrency on the other hand are concerned earnings and reporting on Form 1099-NEC as if it were self-employment income. I highly recommend using TurboTax (premier option) for doing all your crypto tax filing accurately.
With short term capital gains on the rise, 50% in some states when you include state/local taxes, this could make your profits look much smaller.