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Diversifying Your Portfolio: The Case For Cryptocurrencies

Every so often, technological advancements combined with economic evolution give way to a new investment class. This is what happened with gold almost 50 years ago, and has been happening with cryptocurrencies over the last few years. However, despite its immense popularity, there are still many that question even the most basic foundations of cryptocurrency and its underlying technology, blockchain.

What Are Cryptocurrencies?

Cryptocurrencies are digital or virtual currencies that use cryptography for security. A cryptocurrency is impossible to counterfeit because of this security feature. A defining feature of a cryptocurrency, and arguably its most endearing allure, is its organic nature. Cryptocurrencies use decentralized control instead of centralized digital currency and central banking systems. In other words, trust is put into the system itself rather than in a single, authoritative entity that may not always act in the best interest of those that have put their trust in it.

What Is Blockchain Technology?

Blockchain technology is a distributed ledger technology that allows for secure, transparent, and tamper-proof transactions. It is a decentralized system that does not rely on a central authority to verify transactions. Instead, transactions are verified by a network of computers. This makes blockchain technology ideal for applications that require trust and security, such as financial transactions, supply chain management, and voting.

Key Features of Blockchain Technology:

  • Decentralization: Blockchain technology is a decentralized system, meaning that there is no central authority that controls it. This makes it more secure and resistant to attack.

  • Transparency: All transactions on the blockchain are transparent, meaning that they can be viewed by anyone. This makes it more difficult to commit fraud or corruption.

  • Tamper-Proof: Once a transaction is added to the blockchain, it cannot be changed or deleted. This makes it more secure and reliable.

What Are The Criticisms?

To understand this potential investment opportunity, we need to first understand and dispel the negative vibe surrounding cryptocurrencies. Most notably, criticism stems from the fact that no blockchain is governed by a single person or company, but rather by the community of investors that have come together to utilize this technology. This allows a wide range of use cases that have breached other sectors such as health care, real estate, media, automotive, and retail to name a few. Another major concern from potential investors is the lack of regulatory oversight. Several governmental agencies, including the U.S. Securities and Exchange Commission, the Commodity and Futures Trading Commission, and the Internal Revenue Service, look at cryptocurrencies in different ways and attempt to govern them differently as a result. This disjunction from governing bodies brings uncertainty into the markets because they are all saying different things about the industry. Just last year, another Bill was introduced in Congress to provide this regulatory clarity and it seems to have the best chance of becoming law, finally being able to quelch investors’ thirst for clarity.

Despite these concerns, hundreds of millions of investors worldwide have entered the cryptocurrency market. This is because cryptocurrencies provide benefits to market participants. Cryptocurrencies, such as Bitcoin, are rewards for work completed to process and validate network transactions – this work is known as mining. Since these validations are done individually on the publicly transparent ledger, errors and mishaps are eliminated also leading to extremely low processing costs and transaction fees and times, especially when compared to the traditional banking structure.

However, one of the questions for cryptocurrencies is where their underlying values come from. For coins such as Bitcoin, its price fluctuations are derived from the community, scarcity of supply with changing demand. Unlike the United States Dollar, which can be printed, Bitcoin has a fixed supply in its code so that it will never surpass 21 million coins. This gives Bitcoin a unique monetary policy. That combined with its backing of the most powerful and expansive networking of computers leads to its utilization. Other coins, however, have more unique use cases such as Ethereum which powers thousands of applications that run on the blockchain. This is why it is not appropriate to criticize all cryptocurrencies as one since each coin operates differently from another with each having its own unique use case.

Why Invest In Cryptocurrencies?

While cryptocurrencies always have the chance to boom and massively grow in price over time, there are several other reasons why investors should consider adding cryptocurrencies to their portfolios.

First, cryptocurrencies offer a unique opportunity to diversify their assets. Traditional investments, such as stocks and bonds, are often correlated with each other, meaning that they tend to move up and down in price together. This can be a problem if you want to protect your portfolio from market volatility. Cryptocurrencies, on the other hand, are not as correlated with traditional assets, which means that they can help to reduce your portfolio's overall risk.

Second, the increasing inclusion of institutions into the market. While this is most notably coming from the largest US cryptocurrency exchange, Coinbase, partnering with one of the largest investment banks in the world, BlackRock, we have seen many investment banks begin to offer some services in cryptocurrency over the last two years, urged on by their large customers. Additionally, the Nasdaq U.S. stock exchange is also seeking to offer cryptocurrency services, such as custody services to institutions. Not to mention the several investment companies that have come forward to submit their Bitcoin ETF proposals to the SEC.

Third, cryptocurrencies are becoming increasingly mainstream. More and more businesses are accepting cryptocurrencies as payment, and governments around the world are starting to develop regulations for the industry. This shows that cryptocurrencies are here to stay and that their value is likely to continue to grow in the future.

What Are The Challenges Of Investing In Cryptocurrencies?

While there are many potential benefits to investing in cryptocurrencies, there are also some challenges that investors should be aware of.

  • Volatility: Cryptocurrencies are highly volatile, meaning that their prices can fluctuate wildly. This can make it difficult to time your investments and lead to significant losses if you're not careful.

  • Security: Cryptocurrencies are still a relatively new technology, and there are some security risks associated with them. For example, if you lose your private keys, you may lose access to your cryptocurrency forever. The general rule of thumb is “Not your keys, not your coins.” In other words, if you do not have access to the keys for the wallet (i.e. if the wallet is stored on an exchange, where the exchange has the keys, not you), then you do not have ownership of the wallet. Always self-custody your coins in your own wallet (more information below)!

  • Regulation: The regulatory landscape for cryptocurrencies is still evolving, and it's not clear how cryptocurrencies will be regulated in the future. This uncertainty could make it challenging to invest in cryptocurrencies. While various countries around the world have recognized Bitcoin and other cryptocurrencies as legal tender, there is more uncertainty here in the US as the SEC still struggles to understand the industry and propose meaningful regulations. The fact that there are disagreements within the agency suggests that they be unable to regulate crypto, and any new technology for that matter, in a reasonable amount of time.

How To Invest In Cryptocurrencies?

If you're interested in investing in cryptocurrencies, there are a few things you need to do.

First, you need to open a cryptocurrency exchange account. There are several different exchanges available, so you should do some research to find one that is reputable and has a good selection of cryptocurrencies, and is available in your location.

Once you have opened an account, you will need to deposit funds. You can do this by transferring fiat currency (such as USD or EUR) from your bank account to the exchange. Once you have deposited funds, you can start buying and selling cryptocurrencies.

As mentioned above, however, an extremely important step is to set up your own wallet to transfer your coins to once you have purchased them from an exchange. Exodus, MetaMask, TrustWallet, Trezor, and Ledger are some of the more popular wallets available and each offers different levels of protection. Ledger, for example, offers hardware wallets that you connect to your computer via USB and use a software interface to trade your coins. This is considered one of the more secure types of wallets.

How Should You Proceed?

The answer is simple: first, get educated on the industry! The adoption of cryptocurrencies as both use cases and investments should not be confused as validation for any one coin but rather should be understood as an ever-evolving technology that constantly presents new opportunities. While investors should certainly proceed with caution, becoming better educated with the technology and each coin’s use case will allow you to best gauge how the exposure of this lucrative asset class in your portfolio. Second, do your due diligence, research, and analysis before investing. There are platforms, such as Messari and Omnia Markets, Inc. that provide customer education and analytical tools that help make informed decisions.

There are no such things as risk-free investments!

Cryptocurrencies are a new and volatile asset class, but they offer the potential for significant gains. If you want to diversify your portfolio and reduce your risk, then cryptocurrencies may be a good option. However, it is essential to research and understand the risks before investing.

Here are some additional resources for learning more about cryptocurrencies and conducting analyses:

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