July 30, 2021
Crypto is one of the hottest spaces in finance right now, with millions of people hopping in and investing for the first time. However, crypto is not just like trading stocks: it’s a totally different domain for investors. Naturally, this means they’re going to have a lot of questions. This is why we scoured Google and other search engines for some of the most-asked questions about crypto. And, today, we’re answering them in order from most basic to more difficult.
What is cryptocurrency?
Cryptocurrency is an abstraction of ideas in the world of digital assets. To understand what cryptocurrency is, it might help us to start by talking about two unique concepts which have become synonymous with each other:
A blockchain is a ledger of information, which can be likened to a list. When people are talking about blockchain, they are generally referring to the blockchain of a specific cryptocurrency or decentralized network such as Bitcoin or Ethereum (i.e: the Bitcoin blockchain). However, the applications of blockchain are extremely generalizable and far-reaching.
A cryptocurrency is a digital asset used as a medium of exchange, which generally uses blockchain technology and decentralization to facilitate transactions on a network. That network is the respective blockchain for a cryptocurrency.
Over the last decade since the invention of Bitcoin, blockchain technology has evolved.
The core Bitcoin network can exclusively send and receive transactions. However, new-age “second-gen” blockchains and crypto networks such as Ethereum have additional functionality beyond sending and receiving transactions. Networks such as Ethereum have functionality to run apps, execute contracts, store data, and more.
And with new-age networks like Ethereum, have come tokens, copycats, and hundreds of new projects. In 2021, cryptocurrency can be an all-encompassing term for crypto coins, tokens, and other digital assets.
How can I invest in cryptocurrency?
Getting started with crypto can be a little mystifying to first-time investors. Many have jumped in using platforms like Coinbase or Robinhood Crypto, which means they’re ultimately exposed to a “curated” list of digital assets. However, there are over 10,000 cryptocurrencies listed on CoinMarketCap as of June 2021. That means there’s a lot more to crypto than what’s listed on Robinhood and Coinbase.
That doesn’t mean it’s time to go run and look for the smallest, most niche memecoin to invest in. In fact, that sounds like a recipe for disaster. But, what it does mean is that everyone is going to see something different in the world of crypto. You can use your preferred platform to guide your journey when you start, but in your pursuit for value in the world of digital assets, your perspective and experience will be the most useful one.
How should I build my portfolio?
As we’ve already said, the crypto markets are a big place. Your perspective and knowledge will be your guiding light in pursuit of value and profit, but you’ll need to hone that perspective and knowledge in order to be successful. It’s like Warren Buffett says: “the more you learn, the more you earn.”
That said, you might already be asking yourself how to build a crypto portfolio. It’s not an exact science, but when you’re new to the game, you should concentrate the lion’s share of your investments in large-cap cryptocurrencies like Bitcoin and Ethereum. Don’t invest in other cryptocurrencies just to invest in them. Invest in cryptocurrencies that you see the value in.
What constitutes the “lion’s share” of your portfolio might differ from person to person. If you see value in an up-and-coming coin such as Cardano or Polkadot, or want to bet on the growth of decentralized finance projects on blockchains like Ethereum with Uniswap or Compound, then “lion’s share” could vary from 50-80% of your portfolio. However, be wise and strategic about opening positions. You don’t want to go from owning zero cryptocurrencies to owning over 200. That is a tracking nightmare.
Instead, consider dollar-cost averaging your way into assets such as Bitcoin and Ethereum by buying a set amount everyday (say, $5 or $10). Set a comfortable amount and let it ride. Dollar cost averaging (DCA) is a great way to start building your portfolio, because it will take advantage of both the ups and downs of the market. Over the long run, assuming assets appreciate, that means you’re likely to win.
What is the difference between a coin or token?
Seven years ago, nearly every cryptocurrency in existence was a plagiarism of Bitcoin. This meant that the crypto ecosystem was essentially Bitcoin and altcoins such as Litecoin, Dogecoin, and the like. However, with the creation of second-generation blockchain networks, which support more complicated transactions, the rise of tokens began. Since then, the cryptocurrency market has gotten a lot more colorful.
Some of the biggest crypto assets in the world are tokens that live on one or many blockchains. As of June 2021, three of the top ten assets in the crypto markets are tokens. This means, in essence, that these assets exist on the blockchain/network of a larger coin. Those assets include two stablecoins, the Tether (USDT) and USD Coin (USDC), and Uniswap, which exist on the Ethereum network.
In short: coins are generally the currency of a network. Tokens are assets that exist on a network, which can be deployed into a variety of applications. At its most basic, tokens can be used to represent ownership or voting rights in projects or asset pools.
However, the world of digital assets is evolving to reflect the orders of magnitude that exist in our traditional economic system. This is where the abstraction of real, digital, and synthetic assets is starting to develop: allowing for assets to be bridged between blockchains (i.e: you have $USDC on Ethereum and want to move it to Binance Smart Chain), investing in assets that track the price of a stock or commodity, and the like.
It’s still a burgeoning space and, depending on where you live, some pieces might be restricted based on securities law. However, it’s still a development that is very real.
How do taxes work in crypto (in the United States?)
Digital assets are treated as property, which means that crypto is treated a little differently than your stocks. You might be familiar with tax-loss harvesting, which is one way that people can minimize their gains (and, therefore, their tax bill at the end of the year).
In the world of cryptos, your losses are instantly deducted against your gains. Wash sale rules don’t apply, which means that you could sell an asset at a loss and buy it back immediately. It would count as a loss and allow you to open a new position. Feels broken? Because it is. It’s totally legal because the U.S. government does not recognize cryptocurrency as a security. Those rules might change in the future.
Bear in mind, this does not apply to crypto-related securities. You cannot go buy a share of Coinbase, sell it, and buy it back and expect not to get a wash sale. Coinbase stock is a security, which means these rules do not apply.
That all said, one downside of your taxes being calculated differently in crypto land is that you will probably not be getting a pretty tax form furnished to you at the end of the year. At least, not if you’re using a platform such as Coinbase or Gemini. These platforms are not broker-dealers and are not required to furnish 1099-B forms to their customers at the end of the year, which means the burden of producing tax documents re: your transactions to the IRS will have to be done by you at the end of the year (or a third-party program like Cointracker.)
There are platforms that do furnish tax documents for crypto at the end of the year. The two that definitely do are Robinhood Crypto LLC and Uphold, which furnish a consolidated 1099 form for you at the end of the year. You’ll still need to type out or import all your transactions individually, since they’re not reported to the IRS, but that’s still a significant improvement over paying for your transactions to just be listed off.