How to invest in cryptocurrencies
First off, do not use this post as professional investment advice. It’s purely educational and may inspire you to do more research on your own. I’ve been involved myself in cryptocurrencies and blockchain technology for only six months, and this post is a way for me to summarize my sentiment, methodology, and philosophy on investing in this space.
Cryptocurrency investing is a crazy game. If you’re daring and have a lot of money you’re willing to risk, it might be a fun game to play. If you’re not so daring, or you don’t have much expendable income or savings to begin with, I highly advise against investing in cryptocurrencies because no one really knows how much these things will be worth in a few years. Either way, if you’re interested in investing, this post can help you get started with how to think critically and approach all the information that’s out there.
Some Context
Let’s jump right into it. I categorize blockchain projects into 3 categories:
- Moneys (Bitcoin, Litecoin, Ripple, Monero, Zcash, etc.) — These projects are immediate competitors to fiat money, aka they want to replace or significantly upgrade the way use cash today. If these projects are successful, they will majorly replace today’s banks and financial processes. You will be able to use these cryptocurrencies to pay for your coffee, to buy a house from someone, and to save up for your child’s college tuition, with greater security, flexibility, and speed.
- Platforms (Ethereum, Waves, Lisk, Tezos, Neo, etc.) — These projects are paving the way for Web 3.0, the new way the internet is going to work. Developers can use these platforms to build specific applications, the same way that developers today use Swift and Java to create iOS and Android mobile applications. The more successful the child projects that spawn from these platforms are, the more successful the platforms themselves will be.
- Applications (Filecoin, Augur, Golem, etc.) — These are the applications built on top of the aforementioned platforms and comprise the majority of crazy ICO news you’ll read about today. If anyone builds a “decentralized Airbnb”, or a “decentralized Uber”, those projects would fall into this category. They serve particular use cases.
Evaluation Framework
Given this context, how do I evaluate whether or not a project will be successful? I look at three things:
- Market Cap — What problem is the project trying to solve? How much is solving that problem worth? This factor is super important. Even if a technology seems cool or the people working on it are famous, if at this step of your analysis you deem the problem isn’t significant, there may be no reason for you to invest in the solution.
- Founding Team — Why did they make this project, and how serious are they about it? How much knowledge do they have on the subject, and what is their ability to execute on their plan?
- Community — How actively do people talk about this project online? Are there outside developers who contribute to the code? Are people already finding useful applications for the early versions of this project? The success of blockchain projects relies heavily on the network effect.
An Example
Let’s use the above framework and perform an example analysis of Bitcoin, currently the world’s oldest, largest, and most valuable cryptocurrency. The following example analysis leads me to invest in Bitcoin. When you do this exercise yourself, you may not be convinced. Don’t use this example analysis as a justification for your investment; it’s not intended to be used as such. It’s just a quick example of applying the above framework.
Market cap (total value)
Bitcoin wants to be a better version of cash. Let’s assume Bitcoin is able to capture 2.5% of the world’s narrow money flow in 10 years. The entire Bitcoin network would be worth $650 billion dollars, and as I write, Bitcoin has a market cap of about $62 billion dollars. That means the value of the network may grow more than 1000% in the next 10 years. By these assumptions, if I put $100 into Bitcoin today, in 10 years it’ll be worth $1000. This is good.
Of course, I’m making a lot of assumptions here: 1) Bitcoin aims to compete with narrow money flow, 2) Bitcoin will succeed in capturing at least 2.5% of the market, 3) new “coins” are not introduced into the system or destroyed, and on and on..
However, the main idea of this step is to get a sense of the problem that your potential investment is solving, and then figure out the size and value of that problem so that you know how big a slice of the pie you may end up with if you decide to play. The more resources you cross-check for this step, the better your intuition will be.
Founding Team
Bitcoin originated as an idea from an unknown person or group, Satoshi Nakamoto, in 2008, and then was published as open source code in 2009. In a sense, this Satoshi Nakamoto figure comprises the founding team of the Bitcoin project. Even though digital currencies have been theoretically explored since the 1980s, Bitcoin was the first project to become usable and widely adopted, because of the way Nakamoto solved the double spending problem. That’s pretty smart.
Also, to this day, Nakamoto owns around 1 million Bitcoin, which is worth around $4 billion dollars, and according to a couple of sources, including researcher and consultant Ray Dillinger, Nakamoto hasn’t sold a single one of them. Nakamoto didn’t create Bitcoin as a pyramid scheme. They didn’t do it for the money or the fame. They did it because it’s an awesome piece of technology.
Almost 10 years later, Bitcoin is still around and worth $3500 per coin. Passion and principle leading to success. This is good.
Community
To get a sense of how big and vibrant the existing community is around Bitcoin, just Google “Bitcoin”, check out the r/Bitcoin forum, follow the updates to the actual software that makes Bitcoin what it is, or join the Twitter conversation to get a peek. It’s active. People trade it, spend it, debate about what it should be, and most crucially: work on it. This is good.
At this early stage of cryptocurrency technology lifecycle, a good barometer for deciding if the project is overvalued is if the “tech talk” vs “moon talk” ratio is really low. “Tech Talk” = discussion about the technology’s features, use cases, security protocols, and how to improve things. “Moon Talk” = discussion about how many Lamborghinis people are going to buy in a few months after cashing out.
Lots of moon talk, no tech talk -> probably a bubble
Lots of tech talk, less moon talk -> maybe undervalued
Final note
Stay away from pure hype. Don’t throw money into something just because your friend put $1000 dollars into something 6 months ago and it turned into $10,000. Follow the framework above, get as much hard evidence as you can, and most importantly, have fun learning about this amazing new technology! Even if all of these coins are worth nothing in 5 years, the amount I’ve invested has forced me to have “skin in the game” and has fueled me to learn about politics, economics, and cryptography on a deeper level than I ever have before. And I’ve already met handfuls of people who love talking about the technology, writing software on top of it, and researching it. So at least that’s been fun. If you’re okay with that outcome, you might find it fun as well.
If you’re just getting started, here are some more resources:
Keep up with the news
Check cryptocurrency prices
Learn about new cryptocurrency projects
Go to the source
What considerations would you add to this framework? Let me know in the comments down below.
