Despite the dramatic ups and downs of the crypto market, interest in crypto is growing. This growth has helped increase the diversity of investment options in the market.
Retail investors looking to enter the market can now choose between buying crypto outright or buying a crypto-related asset. Those interested in the full experience of crypto ownership may opt for the former, while others may prefer indirect exposure through the latter.
In both cases, the market now offers multiple ways to get in on the emerging crypto markets. Let's discuss the basics of how they work.
What is cryptocurrency?
Before you invest, consider making sure you understand what cryptocurrencies are and how they work.
In a nutshell, cryptocurrencies are digital assets that can be bought and sold. Unlike stocks, however, owning crypto does not give you legal ownership of a company. Instead, you are buying a digital asset you are betting will rise in value. Some cryptocurrencies may also offer some practical utility, like the ability to exchange them for goods and services.
In general, crypto is highly volatile, so make sure you understand the implications of a potential investment before jumping in. Note that crypto may be more susceptible to market manipulation than securities, and direct investments in crypto do not benefit from the same regulatory protections applicable to registered securities. Also, the future regulatory environment for crypto is currently uncertain.
Direct investments in crypto are also not insured by the Federal Deposit Insurance Corporation or the Securities Investor Protection Corporation, meaning you should only buy crypto with an amount you're willing to lose.
Ways to invest in cryptocurrency
If you understand the fundamentals, know the risks involved with investing, and have decided to enter the market, there are a few ways to gain exposure.
1. Buying crypto outright
The most straightforward way to gain exposure to cryptocurrency is by investing in the coins you're interested in. This is most commonly done via a traditional investment platform or crypto exchange.
There are some unique aspects to this strategy. For example, buying crypto outright gives you exposure to the industry in as little as minutes. Entering an order on a traditional investment platform or an exchange can also provide hands-on experience on the buying process, which can be useful for better understanding how crypto works.
Buying crypto outright may give you complete custody over your coins, which allows you to transfer coins between wallets (i.e., personal crypto accounts). This may make it easier to understand how blockchain technology works. And because the markets are open 7 days a week, there's more flexibility to decide when you want to invest compared to traditional assets like stocks and ETFs.
However, there are also risks to be aware of. Before buying crypto outright, consider learning the basics of crypto cybersecurity first. Like any digital asset, crypto is vulnerable to online theft. Transferring coins is also a multi-step process where even small errors could mean losing access to investments forever. And remember crypto is highly volatile, and that there's a possibility that the value of any cryptocurrency can drop to zero.
2. Buying crypto ETPs or crypto-related ETFs on a brokerage platform
There are 2 ways to gain exposure to the crypto industry through funds.
The first is by buying crypto exchange-traded products (ETPs), which give you direct exposure to a cryptocurrency’s value without needing to actually buy the coin yourself. Those who aren’t familiar with the nuances of crypto cybersecurity might find it easier to buy a crypto ETP. And because you can buy ETPs through more traditional routes like brokerage accounts, IRAs, and trusts, tax and estate planning considerations may be simpler to manage compared to buying crypto directly.
Note, however, that ETPs don’t give you direct ownership of the cryptocurrency, and can come with unique trading limitations and investment risks. For example, ETPs can only be traded during traditional market hours, which means holders have to wait until the market opens to enter or exit any positions, even if crypto prices make a large move during the weekend.
Spot bitcoin ETPs are also new, and it remains to be seen whether they will achieve widespread adoption. If they don’t, there could be liquidity issues, i.e., your buys may only get filled at higher prices than what you’re looking for, and your sells may be filled at lower prices. Finally, ETPs don’t remove the security and volatility risks associated with owning cryptocurrencies.
The second way is to buy crypto-related exchange-traded funds (ETFs). Broadly speaking, there are 2 types of crypto-related ETFs. Stock-based ETFs give you exposure to a diversified basket of cryptocurrency stocks (i.e., the stocks of companies that operate in the crypto industry). Futures-based ETFs give you exposure to the futures of either a specific cryptocurrency or a basket of cryptocurrencies.
ETFs that track the broader crypto industry may offer less volatility compared to buying individual cryptocurrencies. Investors looking to invest in the industry as a whole may find it more convenient to buy an ETF, as opposed to buying individual coins and company stocks.
Like ETPs, ETFs don't give you ownership of actual cryptocurrencies, which means they can't be used to pay for goods and services. Also, because ETFs are portfolios made up of multiple investments, the upside associated with individual cryptocurrencies or associated companies can be diluted. If a specific coin or company appreciates in value, you may not be able to capture the same level of growth by holding an ETF. Note that a similar consideration applies to ETPs, which generally do not track the price of the underlying cryptocurrency on a 1:1 basis.
3. Buying cryptocurrency stocks
Another way to invest in crypto is by buying individual stocks of companies in the crypto industry. Examples include crypto exchanges, bitcoin mining companies, and banks that provide solutions for crypto companies.
Crypto stocks offer a way for investors to bet on which companies will lead the industry. And while buying crypto on an exchange incurs trading fees, most major brokerages allow you to trade stocks without fees (though they may still charge a spread).
However, inexperienced investors should be aware this strategy has its risks. Crypto's inherent volatility, poor earnings reports, negative industry trends, and other factors, can all cause a stock's value to plummet.
Less-experienced investors may not want to put all their eggs in the same basket, in which case crypto-related ETFs may be a preferable option.
A note about holding crypto or crypto ETPs in IRAs and crypto 401(k)s
As the market matures, more brokerage platforms and financial services companies are offering the option to hold crypto in retirement accounts.
Those who can buy cryptocurrency in a Roth IRA account may have a potential advantage if the value of crypto continues to appreciate: Tax-free withdrawals on any earnings after age 59 if you've held the account for at least 5 years.
On the other hand, investors should also think critically about the risks. The goal of a retirement account is to provide financial stability for your later years by setting aside money you don't plan on touching for decades. For this reason, portfolio allocation is often built around index and mutual funds, which offer diversification and lower risk than many other options.
In contrast, cryptocurrencies are high risk. They're an emerging investment and their longevity is still uncertain, which may not align with the goal of a retirement account.
What to consider when investing in crypto
Because the industry is still young and volatile, prioritizing risk management over upside may save you emotional and financial stress.
Given the ups and downs, only invest an amount you can afford to lose. This could help you avoid catastrophic financial consequences in the event investments go south.
Finally, remember that crypto may be more susceptible to market manipulation than securities, and crypto holders do not benefit from the same regulatory protections applicable to registered securities. Also, the future regulatory environment for crypto is currently uncertain. Crypto is not insured by the Federal Deposit Insurance Corporation or the Securities Investor Protection Corporation, meaning you should only buy crypto with an amount you're willing to lose.