How to Invest in Cryptocurrency: A Beginner’s Guide to Trading Digital Money
Cryptocurrency is no longer a novelty. From our social media feeds to Super Bowl commercials, digital currency is increasingly mainstream.
But some people remain hesitant about cryptocurrency because of its inherently risky and volatile nature.
In this guide, we’ll explain how to invest in cryptocurrency, including where to purchase digital coins and the safest way to store them. We’ll also dive into fundamental investing principles you should keep in mind to help manage your risk with this new asset class.
What Is Cryptocurrency?
Cryptocurrency is decentralized digital money created using computer networking software.
Most cryptocurrencies are based on blockchain technology.
Unlike traditional currencies — which are controlled by central banks — cryptocurrency doesn’t require a government or central authority to verify transactions.
You can use crypto to buy certain goods and services. You can transfer it back and forth to other users. Or you can buy and trade it like an investment.
Bitcoin is the oldest, most popular and most valuable cryptocurrency. It was created in 2008 and its share of the total cryptocurrency market was roughly 43% in 2021.
Still, the crypto universe is immense and complex. There are literally thousands of alternative cryptos — also known as altcoins — available to trade around the world, with a global crypto market cap of about $1.9 trillion.
Some cryptocurrencies are more about tech and less about investing: These cryptos are mostly designed to help run computer networks that carry out complex financial transactions.
Cryptocurrency is supported by blockchain technology, which operates a tamper-resistant record of all transactions ever made using that cryptocurrency.
Transactions are grouped together and recorded as “blocks” that are then linked together on a “chain” of cryptocurrency transactions.
Some cryptocurrencies are created through a process known as mining. There are two primary ways to mine crypto: proof of stake or proof of work. Both are validation techniques used to verify transactions before they’re added to a blockchain.
For the average person, the easiest way to get cryptocurrency is to buy it — either from an exchange or a broker.
How Do You Start Investing in Crypto?
Buying crypto has never been easier. You can purchase it on your smartphone or computer.
You’ll need to set up an account with an online exchange or crypto broker to get started.
You’ll also need to research the specific cryptocurrency you want to buy to make sure it’s a good fit for your investment portfolio and risk tolerance.
Decide Where to Buy Your Crypto
There are two primary ways to buy cryptocurrency.
- On a centralized exchange.
- Through a cryptocurrency broker.
As you explore your options, see which cryptocurrencies are offered on each platform and pay attention to transaction fees. Find out how easy it is to transfer your digital assets to an external wallet and examine the platform’s security features.
A crypto exchange is an online platform you can use to buy and sell cryptocurrency.
The vast majority of crypto trading takes place on centralized exchanges.
Some of the largest crypto exchanges include:
You can use exchanges to trade one crypto for another — converting Ethereum to Bitcoin, for example — or to purchase crypto using fiat currency, like the U.S. dollar.
You can also convert cryptocurrencies back into U.S. dollars, leave money as cash within your account or withdraw cash to your regular bank account.
While cryptocurrency itself is largely unregulated, centralized exchanges are regulated. Most of these companies require users to follow Know Your Customer rules to combat money laundering and fraud. This means you’ll need to provide private information about yourself like you would when applying for a traditional financial account.
Exchanges have also tightened security protocols in recent years. They now store most customer assets offline and take out insurance policies to cover losses in the event of a hack.
Most exchanges charge transaction fees that range from 0.5% to 4.5%. The fees can differ depending on whether you’re the seller or the buyer.
Cryptocurrency exchanges aren’t always transparent about their fee structures either. They can fluctuate when demand is high or for no apparent reason at all.
However, higher fees on a well-established cryptocurrency exchange may be a worthwhile tradeoff for new crypto investors because they offer added protections and insurance.
They also offer more control over your assets and a wide selection of cryptocurrencies.
Online brokers make it extremely easy to invest in cryptocurrency. They offer simple interfaces that interact with exchanges for you.
Some of the most popular crypto brokers include:
- PayPal and Venmo
- Cash App
Some brokers like PayPal offer other financial services. And some, such as Robinhood and SoFi, give users access to the stock market.
While crypto brokers are incredibly convenient, but they aren’t well suited for long-term investing.
Most brokers (including PayPal and Venmo) don’t allow you to move your digital currency off the platform. Instead, you must sell your coins and transfer the balance to an external account.
In this way, you don’t really “own” cryptocurrency purchased on these platforms.
That’s not a huge deal if you’re just starting out. But it’s something to keep in mind if you continue to invest in cryptocurrency.
Brokers also offer fewer types of crypto coins than exchanges do. For example, Venmo offers just four and Cash App offers only Bitcoin.
Some online brokers charge higher fees than exchanges. Others (like Robinhood) claim to be free, but really, they make money by selling information about what you and other traders are buying and selling to large brokerages or funds. Or, they may not execute your trade at the best possible market price.
Create and Verify Your Account
Once you’ve picked your crypto broker or exchange, it’s time to create and verify your account.
Exchanges generally require strict identity verification processes. You’ll need to submit a copy of your driver’s license or passport, and you might be required to upload a selfie to verify that your appearance matches the documents you submit.
It might seem like a hassle, but these steps are essential (and required by U.S. law) to prevent fraud and hacking.
You may not be able to sell or buy cryptocurrency until you complete the verification process.
Fund Your Account
If you’re a first-time buyer, you’ll probably use regular fiat currency (aka dollars) to buy crypto.
You can fund your account via debit or bank transfers. It’s a lot like a traditional brokerage account that way.
Pick Your Crypto
There are literally thousands of cryptocurrencies. You’ll have plenty to choose from.
In fact, the sheer number of options can make buying cryptocurrency intimidating for newcomers.
Don’t get overwhelmed. Most cryptocurrencies aren’t worth anything and many sputter out shortly after creation.
Most major exchanges offer less than 100 different cryptocurrencies. (Coinbase offers about 50, Gemini offers about 70 and Kraken has about 110). These exchanges focus on the most popular and viable coins with respectable market caps.
Most experts agree that new crypto investors should get their feet wet with established coins that have built-out networks backed by proven technology.
While all crypto carries risk, the biggest players — Bitcoin and Ethereum — are considered more stable and demonstrate a longer track record of increased value than other crypto investments.
However, if you’re determined to buy the latest obscure altcoin your friend told you about, keep in mind that lesser-known coins are typically listed on just one or two questionable exchanges. You’ll likely need to register on multiple exchanges to access such coins.
- Bitcoin: The first and most valuable cryptocurrency. In May 2016, you could buy one Bitcoin for about $500. By March 1, 2022, a single Bitcoin cost over $44,000. There’s a limited supply of this digital currency, so supporters believe the price will keep climbing over time. Fans have nicknamed it “digital gold.”
- Ethereum: The second largest crypto by market share. Ethereum is a blockchain platform created to support smart contracts and secure financial transactions. Most nonfungible tokens, or NFTs, are based on the Ethereum network.
- Cardano: A competitor to Ethereum led by one of its co-founders. Like several other projects, Cardano aims to carry out a range of complex transactions without the help of a bank or other middleman.
- Solana: Another competitor to Ethereum. It was developed to help power decentralized finance uses and smart contracts. It can process these transactions much faster than Ethereum.
- Dogecoin: This crypto began as a joke but has turned into a profitable cryptocurrency for some investors.
- Stablecoins: A class of cryptocurrencies whose values are designed to track the value of real-world assets. USD Coin is one example.
Orders on an exchange work the same as orders in the stock market.
An exchange will match your buy order with someone making a sell order at the same price, then execute the trade.
All cryptocurrency exchanges let you buy fractions of crypto. You don’t have to buy an entire Bitcoin — you can buy just $50 or $75 of it if you want.
Once your trade is complete, the exchange holds your cryptocurrency for you in a custodial wallet.
Store It In a Wallet
When you buy cryptocurrency, it’s typically stored in a custodial wallet attached to the exchange.
If you want more ownership over your crypto holdings, you can transfer them off the exchange to a separate hot or cold wallet. This gives you more financial freedom and direct ownership over your coins without relying on a third party.
- Hot wallets: Also known as software wallets, these wallets are stored online and run on Internet-connected devices, like computers or smartphones. Hot wallets are convenient, but they’re susceptible to hacking since they’re connected to the Internet.
- Cold wallets: Cold crypto wallets — also known as hardware wallets — aren’t connected to the Internet. They’re considered the most secure way to store your crypto. It’s the preferred storage method for serious cryptocurrency investors. Cold wallets are external devices, like a USB drive or a hard drive. The danger with cold wallets is if you lose or break the device, your cryptocurrency is gone forever.
A crypto wallet consists of two main pairs: private keys and public keys. A public key serves as the address used to send crypto to the wallet. Think of it like your public email address.
Meanwhile, a private key is like the key to a safe deposit box. Anyone who has access to the private key of a wallet can take control of the digital assets inside.
If you’re buying cryptocurrency via a broker, you may have little to no control over how your cryptocurrency is stored.
Creating and setting up a wallet requires time and research. If you’re just starting out, you can leave your crypto on an exchange or with a broker for now.
If you continue to invest in cryptocurrency though, do your due diligence and see what type of wallet is right for you.
Cryptocurrency Investing Guidelines
Investing in cryptocurrency isn’t like investing in other traditional assets. However, many established investing principles still hold true.
Here are a few guidelines on how to invest in cryptocurrency if you’re just starting out.
- Shore up the rest of your financial life. Before you plunge into crypto, create a cash emergency fund, set up a retirement account and get credit card debt under control.
- Consider crypto’s place in your portfolio. Because cryptocurrencies are volatile, high-risk investments, experts recommend allocating no more than 10% of your entire portfolio to Bitcoin and other digital currencies.
- Don’t invest more than you’re willing to lose. Starting small and growing your investments over time is a smart way to get more familiar with the price swings and mechanics of cryptocurrency investing without exposing yourself to unnecessary risk.
- Do your research. This is critical if you’re investing in small altcoins. Learn about the development team. Read the white paper and market research. Comb Reddit forums and immerse yourself in the crypto community. The more you know, the more likely you are to make smart investment decisions.
- Manage your risk. If you’re a long-term investor, this might mean sticking to a couple well-known coins and holding, no matter how turbulent the crypto market gets. If you’re investing for short-term gains, you might manage risk by sticking to strict rules on when to buy and sell, like when an investment falls 10 percent or more.
Frequently Asked Questions
Yes. If you sell your crypto assets for a profit, you’ll owe taxes to the IRS on the difference between what you originally paid for the digital asset and what you sold it for.
The IRS suggests keeping records of any time you receive, sell or exchange virtual currency, as well as the fair market value of your crypto.
Some exchanges may issue you a Form 1099-B to help you calculate gains and losses — but don’t count on it. Coinbase, for example, doesn’t provide this information to users.
If you hold the crypto for a year or more, you’ll owe long-term capital gains tax. The profit will be taxed at 0, 15 or 20 percent, depending on your tax bracket.
If you hold the crypto for less than a year, you’ll get taxed at the short-term capital gains rate, which is the same as what you pay on your ordinary income.
If you’re executing multiple crypto trades on a regular basis, your tax situation can get complicated fast. You may want to speak with a tax professional before you get started.
Remember: You’ll only owe taxes if you sell your crypto for a profit. If you sell at a loss, those losses can help offset your capital gains tax. You won’t owe taxes until after you sell an asset.
Decentralized exchanges, or DEX, are a less-common way to purchase cryptocurrency.
These exchanges offer some additional security. (Because they’re decentralized, there is no single target for a cyberattack.)
Their fees can also be lower.
However, DEX are less user-friendly and require more advanced technical knowledge to navigate. For example, decentralized exchanges don’t always let you deposit U.S. dollars and exchange them for crypto.
More companies are accepting Bitcoin as payment, from local businesses to major corporations including Microsoft, Overstock.com and Shopify.
A crypto debit card is the easiest way to buy goods and services with Bitcoin.
These debit cards work like traditional debit cards, except instead of cash, you preload the card with Bitcoin or another cryptocurrency.
Crypto debit cards also let you withdraw cash from qualifying ATMs, and they partner with Mastercard and Visa to carry out transactions.
If you hold crypto with a broker like Robinhood or PayPal, you can simply sell your cryptocurrency holdings on that platform. The same holds true if your crypto is on a centralized exchange.
If your crypto holdings are stored in a wallet, follow these steps: Connect your wallet to an exchange. Make sure the exchange supports both the wallet and the asset you want to sell.
Move your cryptocurrency onto the exchange. Sell it for U.S. dollars. Transfer the cash to your bank account.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder.