Cryptocurrencies are digital currencies designed to function as a means of secure transactions due to cryptography. Being digital, they do not have a physical state but function as a virtual payment option when used in commerce. Because of this, investing in cryptocurrencies is often compared to no account casinos that are associated with the desire for easy money.
Cryptocurrencies are considered a type of currency with similar properties to traditional currencies, but they are notoriously different in that they are digital and do not depend on a bank for their operation; on the contrary, they rely on a system, generally decentralized, and a sequence of parts that can allow their operation.
This means of payment is established from mathematical algorithms that use many servers for production and operation.
Features of cryptocurrencies
The main features of cryptocurrencies are the following:
They employ encryption or encoding techniques (cryptography) that grant peace of mind to the parties involved during the transfer of assets since they prevent counterfeiting or duplication of the digital currency.
They are interchangeable like traditional currencies since you can exchange them for other currencies.
They do not require intermediation by a bank or a third party; the contact is from person to person, thus avoiding the costs charged by financial institutions.
Your transactions do not require the declaration of identity of any of the intervening parties.
Settlements of your purchase and sale are resolved in a matter of minutes. While Internet payments are generally fast, some traditional online transactions may require more time.
What are the risks of cryptocurrencies?
Within the risk spectrum, cryptocurrencies are definitely on the riskier side. You need to understand how or why prices move (unlike companies, cryptocurrencies don't release quarterly results). You probably know that factors such as media coverage and general sentiment (how people feel about a cryptocurrency at any given time) can affect the price, but big moves often happen without warning. Usually, it's simply due to the most fundamental law of supply and demand.
That means your crypto investment could skyrocket or plummet to a fraction of its worth. Cryptocurrencies are also volatile, but this is not the same as having risk. Risk involves making or losing money when you plan to hold your investment. Volatility refers to the amplitude of the daily price movements of an asset. In the case of cryptocurrencies, those movements are significant. On some days, the price of a cryptocurrency like Bitcoin varies by more than 10%, something that, with most stocks, doesn’t happen often.
How to invest in risky and volatile assets
You already know that cryptocurrencies are risky and volatile. Does this mean you shouldn't invest in them?
Not necessarily. Adopting a very low-risk investment profile may protect you from suffering significant losses, but it will also prevent you from being able to make large profits. This is called opportunity cost and refers to the money you could have made without playing it safe. The easiest way to avoid excessive risk is to make it a small part of your portfolio. If you keep most of your investments in low-risk assets such as ETFs, you can be slightly more adventurous with the rest.
This way, you can take advantage of some benefits. For example, if that small investment works, it could improve your portfolio quite a bit, and if you lose a significant portion, it will keep your investment goals high.
