Some Things to Consider When Investing in the Volatile Cryptocurrency Market, Part I

INTRODUCTION

There are a number of reasons that more and more investors are being attracted to the possibilities of investing in the growing cryptocurrency market. What is driving growth in the sector is an emerging recognition by a greater number of people of the potential for Blockchain technology and cryptocurrencies to fundamentally impact the financial services industry, as well as many other sectors from healthcare to insurance.

Cryptocurrencies, also referred to as digital currencies or money, altcoins, or digital assets, represent a global market that is still in the early stages of being recognized by investors. It is still very early in the growth curve as Wall Street is only now starting to acknowledge cryptocurrencies as a new asset class. Demand will continue to be boosted as acceptance expands by both retail and institutional investors. Of course, there are those prominent on Wall Street who disagree with this assessment, but the evidence seems to show otherwise. There are now over 70 funds focused on the market with new funds announced every week.

DIGITAL CURRENCIES

For the purposes of this article we are mostly referring to the biggest and most active cryptocurrencies, which include Bitcoin (BTC), the largest by market capitalization at over $81 billion, and then others that are not as well known to the general public. In order of market capitalization the next five largest after bitcoin are ethereum (ETH), ripple (XRP), bitcoin cash (BCH), litecoin (LTC), and dash (DASH). When combining all six together we’re looking at a market capitalization that exceeds $129 billion. Then, if we include the hundreds of other digital currencies the market value goes to roughly $200 billion, approximately equivalent to the market value of Citigroup alone. In other words, the market is still very small when compared to the stock market or most any financial market for that matter.

Historical logarithmic chart for Bitcoin/Dollar

Historical logarithmic chart for Ethereum Classic/Dollar

INVESTORS FOCUS ON THE BENEFITS

First, let’s mention some of the benefits of participating in this market and then we’ll look at risks.

  • Can provide diversification for an investment portfolio
  • High volatility with the potential for above average returns
  • Separate asset class with distinct influencers
  • Not correlated to traditional asset classes
  • Growing worldwide demand and acceptance
  • Expanding market size.

Exposure to cryptocurrencies can help with diversification of a portfolio as they’re not impacted by the same developments that impact other asset classes such as stocks, commodities or currencies. As recognition grows, demand for these digital assets will surely grow with it. The activity of investing and trading in cryptocurrencies operates in its own world mostly separate from the traditional financial services infrastructure. This makes it a little more complicated to get involved but certainly accessible to the average investor.

Volatility risk can equal greater opportunity

The highly volatile nature of digital currencies is seen as a major draw by investors. Just in the past 30 or so days bitcoin has gained more than 90%. That’s after dropping 40% in 14 days prior from a record high of $4,979.90 reached at the beginning of September. Meanwhile, ethereum is up over 3,900% year-to-date and had recent swing of over 65% down in four weeks, followed by an advance of 190% in only seven weeks. These types of swings may be dangerous but they also create opportunity.

RISK

Investing in cryptocurrency is a highly speculative market and is not considered to be a safe investment. It is about as high risk as one can find. But, that risk can be compensated for by the higher return potential, and the speed in which a return might be recognized. Therefore, there are a number of things an investor can do to help diminish the impact of higher risk, including:

  • Have a clear investment plan prior to engaging the market. What are you trying to accomplish?
  • Use lower position size than what seems necessary
  • Only put capital at risk that you can afford to lose
  • Have a clear risk management strategy. Know when to get out if you are wrong
  • Once you make back your principal take it out and then invest only with your profits
  • Scale out of profitable positions. Take profits off the table.
  • If your portfolio size justifies it you can also use multiple exchange venues to compensate for the risk of trouble at the exchange level.

INVESTMENT STRATEGY

One of the first things to do to get involved is determine how much money and time you have to invest, what is your current skill and knowledge level and what needs to improve in that regard, plus, what approach you are going to take when investing. Are you going to get in and out as the market swings up and down, keeping in mind that Bitcoin for example can see swings in either direction of greater than 30% in weeks? Or, are you going to take a long-term buy and hold approach, and not worry about significant drops that may occur?

In the first direct participation approach one must have a strategy to identify when to get in on dips and out on rallies. Usually, this is going to come from the use of technical analysis and charts, which are tools to help with the timing of entries and exits. With the second strategy one must be willing and able to sit possible large and long-term losses or drawdown, while waiting for strength to return to the market. A drawdown is the percentage decline from the peak of your portfolio value.

An alternative to a direct participation approach is to invest in a coin traded fund (CTF) that matches your strategy, like The Token Fund for example. A CTF has a prebuilt portfolio of cryptocurrencies that matches your strategy. This can provide some degree of diversification among the many cryptocurrencies out there and give you wider exposure than you would likely get on your own. CTFs offer a painless entry into the crypto world that comes with the benefits of a diversified portfolio and they don’t require your constant attention and maneuvering on exchanges.

In the second part of this series we’ll take a look at some of the mechanics involved with investing in cryptocurrencies and expand on topics touched on in this first article.

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