Cryptocurrencies: What you should know before investing

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Three years ago cryptocurrency was banned in India by the RBI. Few Indians understood what bitcoin was and even fewer knew what cryptocurrency meant. Today, everyone has that one friend that got into Bitcoin, made some money on it, and won’t stop talking about it. In more recent times,  the crypto space has exploded with the total market cap almost doubling in 3 months- $1.1 trillion to $2.1 trillion at its high- falling back to $1.87 trillion today. 

The above numbers alone will give you a fair idea of the intrinsic attributes of this novel asset class- in terms of the volatility and investor sentiment driving it. 

These currencies have recently gained recognition and are quickly being established in the portfolios of institutional and retail investors despite continued warnings from analysts. This extensive momentum has resulted in a crucial mistake that many rookie investors have made: getting tied up in “the hype” in the fear of missing out. 

Treat this asset class like any other and do your due diligence. 

  • Spend time understanding the basics of bitcoin (the originator of this asset class), research on the fundamentals, and the underlying tech of different currencies
  • Read published whitepapers that govern your specific currency
  • Be strategic about the quantum of investing in terms of how much percentage of your portfolio it constitutes (and what you can afford to lose)
  • Time your investment after monitoring market sentiment based on online platforms where crypto enthusiasts cluster.  

Understanding the basics of Bitcoin

A cryptocurrency is a digital asset that runs on a network that uses cryptography to ensure transactions take place in a decentralized and secure manner. Bitcoin is the "origin-story" equivalent of crypto, was released in 2009, and dominates the market in with an $800 billion market capitalization. It is also the most volatile and the most difficult to mine. Due to its popularity, it is sometimes misunderstood as being cryptocurrency as a whole itself. However, in today’s crypto ecosystem there are over 10,000 currencies that have different use cases and underlying technology that govern them. Some of the most prominent ones include Ripple, Ethereum, Litecoin, Dogecoin, Dash, and Monero. 

​​​​What is bitcoin backed by?

Nothing, Bitcoin is not asset/commodity/fiat backed. It is the trust in the systems that support it. The governing technology is known as Blockchain. This is nothing but a type of Distributed Ledger Technology (DLT) - A decentralized database of transactions maintained across different nodes, eliminating the requirement for a centralized authority to keep a check against manipulation. The information on the ledger is stored cryptographically, in a secure and accurate manner, and would be accessible using keys or digital signatures. In the specific Blockchain case, this ledger also has specific design features such immutability (it is unchangeable) and runs on a consensus algorithm (everyone on the blockchain has to agree as to what the most accurate ledger is).

Bitcoin is an application of Blockchain and derives its value from market dynamics of supply (limited) and demand. As opposed to fiat currency, bitcoin’s value is not guaranteed by the full faith and credit of a government or organization. Its value therefore mirrors true market fundamentals (in theory).

The Right Time to Invest in a Cryptocurrency

Fundamental factors are very important to consider when assessing any investment decision. For example, the price is not necessarily indicative of how valuable the product will ultimately be. It isn’t as simple as understanding the dynamics of demand and supply. You need to compare the fundamentals of the currency to those of a product in order to determine if the currency is overvalued or undervalued. Understanding its intrinsic value and forming a vision around its prospective use case will help you develop your investment thesis. You can then consolidate your thesis by reading the research performed by reputable financial analysts that cover the currency.

Due to the high volatility, timing plays a crucial role in your investment (more than other assets). Once you have formed a thesis around the currency you should keep a close eye on the industry through online community platforms where crypto-traders congregate. This will help you get a feel for the investor and market sentiment which will help you increase your probability of pricing yourself during periods of high volume trades and momentum within the market. 

Conclusion

We're at a fascinating time in the cryptosphere (yes, I just made this up). New technologies, including blockchain, are being developed at an incredible pace resulting in the cryptocurrency market gradually catching up. This is not to say we’re in a bubble, but it is certainly a transition phase. Many have realized that these currencies and the system around it is not mature enough. We’re seeing a classic case of the lag between disruption and regulation to the point where the infrastructure around crypto is still in the early stages without a clear use case for many of these new assets. 

In the meantime, if you want to capitalize on this emerging asset class, keep a cool head and remain focused on the fundamentals of your investments. 

This is what separates successful investors from those who are simply trying to get in on the boom.

Author: Team dezerv.

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