The very fact that the crypto-sphere is hyped in today’s day and age shows that the world is increasingly going digital. Yet, the mainstream view is still predominantly associated with Bitcoin – the first and the most popular cryptocurrency. While it is benign to hold such a vantage point from a layman’s perspective, as an investor, it is an opinion that limits insight and practically drains the entire portfolio.
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As many investors are starting to allocate funds to this asset class, this article could guide you through the fundamental knowledge about the crypto-world. However, bear in mind that the market is decentralized and highly volatile. Therefore, while the basic tenets would apply irrespective of the timeframe, some valuations could drastically differ over a period.
For real-time prices and market cap:
What is a Blockchain? And what exactly is Decentralised Finance?
A majority of investors are still confused about the difference between blockchain technology and decentralized finance. Both terms are interrelated but differ in the scope of application in the real world. Blockchain technology is a system that acts as a digital ledger to facilitate transactions distributed across a diverse network of computers. It is basically a system of digitally encrypting and recording information duplicated over an expansive network: making it impossible to hack, alter, or corrupt data while being processed or stored. The technology is extensively used in logistics services, allowing users to keep real-time track of their packages around the globe. The most widely known implementation of blockchain technology is in Crypto Financial Services.
Colloquially referred to as ‘DeFi,’ the sector of Decentralised Finance spreads across a complex array of digital products: from cryptocurrencies to NFTs. DeFi involves a skeleton of blockchain technology to operate a colossal network of shared ledgers. With no centralized authority to verify transactions and manage supply, this area of finance uses complex algorithms to distribute the verification and storage process among users themselves. Due to the surfeit number of operants, rigging the system is rendered almost impossible. Thus, making DeFi one of the pioneering shifts in traditional financial services of modern time.
Bitcoin is probably the best-known example of this vast field of decentralized finance and mass implementation of blockchain technology across countries.
What is Bitcoin? How does it differ from blockchain?
Arguably the most common misconception shared amid the new class of crypto-enthusiasts is that both blockchain and bitcoin are alike. As aforementioned, blockchain is the broader technology utilized by various industries. One such implementation in the finance industry (specifically the financial services industry) is Bitcoin: a digital token exchanged as a means of value over a system of shared ledgers called blocks. Created in the wake of the 2008 financial crisis by an anonymous entity – under the pseudonym ‘Satoshi Nakamoto’ -, the encrypted token acts as a pseudo-currency with a free-float valuation. Traded across a complex platform cohesively structured as a shared ledger system, the value of bitcoin is impossible (by default) to control and dictate.
Participants verifying the transactions – frequently known as ‘Miners’ – use sophisticated computer programs to solve intricate hash functions to add blocks of transactions to the bitcoin blockchain. In exchange, they earn a lump sum of 6.25 BTC. This mechanism of Proof of Work (PoW) is proven to be impenetrable to external influence due to this distributed functionality and vast amounts of energy required to solve functions and add blocks of transaction data. However, it is susceptible to speculation that ultimately fuels the volatility feared by investors. Many elicit a question then: is it worth the risk?
Is it actually risky to invest in Bitcoin? How to avoid that risk?
A fact is inherent to the word investment itself: the more the uncertainty, the more the reward. This quality is not specific to bitcoin but every risky asset in general. Take traditional investors, for instance. These investors – having a risk appetite – invest in Junk bonds: to gain higher than average returns in exchange for the unpredictable nature of a potential default. What makes Bitcoin so unique, however, is its on/off vacillation in the mainstream debate: making a takeoff in value as likely as a dip. When it first began trading in 2009, price swings were limited as the adoption was gradual, and the information was sparse during the early days. However, in recent years, both the adoption and information have skyrocketed. The bitcoin market capitalization breached the $2 trillion mark last year: making it the first non-corporate entity to hold such prohibitive valuation. Governments have started adopting the coin as an official means of value exchange. And even renowned Investment Banks and hedge funds are offering services in digital tokens.
Despite slipping by 40% from the record-high price of $69,000 in November, bitcoin is currently trading at a support threshold of $42,000 – still up by almost 500% since the end of 2019. So is it risky? Absolutely it is! Compared to other assets in the market, it is a riskier store of value: in contrast to the popular notion of crypto fanatics. However, when comparing risk-adjusted returns, bitcoin shows outperformance relative to other assets. For example, bitcoin’s risk-adjusted return since September 2020 has been more than twice the performance of the S&P 500 index. Over the same stretch, Treasury bonds have posted negative returns while commodities have fared far worse. The same trend holds true for multiple periods – whether the start of 2015 or the beginning of 2020 – where bitcoin has outright trounced the traditional investment streams.
However, the astronomical returns flowed to investors who stomached the churn of massive decline preceding the surge in value. Whether it was the crash of 2017 – when bitcoin tumbled by 80%. Or the slump of 2021 – when China’s mining crackdown led billions of dollars in liquidity squeeze to push the market to a halt.
In short, it is the scheme of time, temperament, and a thrill for greater risk that is keeping the bets alive. Therefore, for greater returns, a temporal loss should enjoin long positions instead of divestiture.
So what is the optimum strategy to invest in the crypto-sphere? And when should it be implemented?
The year 2021 was the most unstable year for the crypto-world. The Non-Fungible Tokens (NFTs) saw a sharp increase in popularity while a slew of cryptocurrencies lost more than half of their valuation before a skyrise. However, 2022 is about to change the dynamic to a greater extent. As the US fed prepares over its hawkish tilt with talks over bond taper and rate hikes, the valuation of cryptocurrencies – particularly bitcoin – is expected to plunge in the following months. According to Crypto gurus, the cryptocurrencies would remain under pressure as the fed reduces its liquidity injections. Further, as regulations get tightened by the SEC, the popularity could take a hit as well.
Thus, my advice is to wait out the year 2022 as bitcoin would probably end 2022 below the $20,000 mark. If, however, your investment is geared towards the broader world of cryptocurrencies in general, my advice would differ. My approach would be to include bitcoin but diversify your allocations. My advice would be to allocate weighted portions of your portfolio to similar tokens like Ethereum and Solana. While these tokens move in tandem with the price swings in bitcoin, their operation hasn’t reached such a meteoric level of scale in the investor community. Instead, their adoption has been limited compared to bitcoin. And therefore, they offer more upside in terms of growth without steep price swings. Ethereum, for instance, currently trades around $3,000 and generally deviates in a $500-$1000 window in the medium-run.
If you are looking for more ingrained diversification, I advise some allocation of funds in the metaverse: more closely tied to the revolutionary side of NFTs. Purchasable tokens like Sandbox (SAND) and Decentraland (MANA) would serve as a lucrative option in the portfolio. These NFTs are available on most crypto platforms and have offered steep returns over an extensive period of time. Moreover, alongside a motley of cryptocurrencies (weighted appropriately), these could also work as a hedge to bets in bitcoin because of high liquidity and profitability: making the portfolio optimum in terms of longer-term technical bets.
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Ultimately, as an investor starting to invest in this strata of assets, you need to have a long-term approach, a stomach for risk over an extended period of time, and an astute eye for market regulations and announcements to derive appreciable gains. Remember, there is no magic or free lunch when investing. The offerings have innovated, the platforms got digitalized, but the basics are the same – patience and diversification.
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