Investing in Cryptoassets
Cryptocurrencies as an Investment
Although originally meant to be a form of exchange, many cryptocurrencies have instead become assets—rather than using Bitcoin to pay for cups of coffee, for example, people are buying and holding Bitcoin as a long-term investment.
In general, it’s helpful to think about cryptocurrency as a commodity investment. Most of those who buy and hold coins do not expect to generate income—although, as we will discuss below, a growing array of new lending products do offer income generation—but instead anticipate benefiting from long-term capital appreciation. In other words, investors generally see cryptocurrencies as a store of value and an inflation hedge—as “digital gold.”
By design, cryptocurrencies are fungible and tradeable. That makes them ideal for investment purposes and—as we will discuss in more detail below—for use in the development of complex investment products.
Other Investable Cryptoassets
Although cryptocurrencies are by far the most popular option, the investable crypto universe extends beyond them.
NFTs, for example, have enjoyed a burst of popularity. However, while investing in cryptocurrency is similar to investing in other fungible commodities, investing in NFTs is more complex. Because each NFT is unique, they do not lend themselves to the creation of investment products. Instead, investing in NFTs, like investing in traditional art, relies on the discretion of the buyer. Those who invest in NFTs are generally seeking long-term capital appreciation.
Security tokens have also attracted investor interest but are also very different from cryptocurrencies. Investing in security tokens is much like investing in traditional stocks—it primarily requires a good understanding of the underlying asset, rather than the token itself. Investors may earn dividends from the company issuing the tokens or, in the case of security tokens representing real estate, may receive rental income flows, as well as long-term capital growth.
How to Invest in Crypto
Despite its growing popularity, there is still significant confusion and misinformation surrounding crypto investing. It is important that investors—and advisors—fully understand what they are buying and how to access, trade, and store it. There are, broadly speaking, two ways to invest in crypto.
Directly Purchasing Tokens
This is the most popular method of investment. It involves purchasing tokens—cryptocurrency coins, for example, or NFTs—and holding them in the hope that they will increase in value.
Most direct token purchases happen through crypto exchanges. These third-party platforms allow users to purchase and sell tokens using either fiat money or cryptocurrency.13 A user may, for example, use a crypto exchange to purchase Bitcoin using U.S. dollars, or to purchase Ether using Bitcoin.
NFTs are typically purchased through third-party marketplaces using cryptocurrency.14 Therefore, someone wishing to purchase an NFT might first purchase the necessary cryptocurrency through a crypto exchange and then buy the NFT through a marketplace.
The quality, reliability, cost, and security of these third-party players vary significantly.15 While many crypto exchanges are reputable, registered financial firms, many others are unregistered or registered in jurisdictions with limited regulatory oversight.
Over the years, there have been many prominent security failures at crypto exchanges that have resulted in users losing millions in cryptocurrency or having their identities stolen.16 The fees levied by different platforms also vary greatly. For these and other reasons, it is essential to do due diligence before using a particular platform.
Importantly, investors must also understand what they are buying and where it will be stored. On some platforms, users do not actually directly purchase cryptocurrency tokens. Instead, they purchase exposure to cryptocurrency movements—often without realizing that this is the case. On other platforms, users do not gain direct control of their coins. Instead, their coins are stored in crypto wallets (see Box 3) on the exchange’s network. This can cause issues including security vulnerabilities and loss of access to purchased assets.
Investing in Registered Products
An emerging option for crypto enthusiasts is to invest in registered crypto-linked products.
With very few exceptions, most crypto-linked products are associated with cryptocurrencies, rather than other types of cryptoassets—as discussed above, the design of most cryptocurrencies lends itself to the development of investment products in a way that other tokens’ designs do not. In addition, most registered products are linked to either Bitcoin or Ethereum, the two largest cryptocurrencies by market capitalization. For those wishing to invest in other coins, direct investment is likely necessary.
For qualified investors, there are privately managed funds that directly invest in cryptocurrencies. Those funds handle the management and storage of the assets, as well as the selection of different tokens, and can be a good option for investors who want exposure to the asset class but do not want to manage their own holdings directly.
Perhaps more interestingly, there is a growing array of cryptocurrency-linked derivatives, including futures and call/put options. Like other derivatives contracts, crypto derivatives trade over exchanges and are generally highly regulated, offering investors exposure to price movements and the ability to use leverage. As with other derivatives, however, they require a degree of investor sophistication. There are also exchange traded notes (ETNs) and exchange traded funds (ETFs) that offer investors exposure to cryptocurrency price movements and the ability to use leverage. As with other derivatives, however, they require a degree of investor sophistication. There are also exchange traded notes (ETNs) and exchange traded funds (ETFs) that offer investors exposure to cryptocurrency price movements.
Emerging Income-Generation Options
So far, we have focused primarily on investing for long-term capital appreciation. Increasingly, however, financial firms are also offering cryptocurrency lending products that promise income.17 For those who have bought cryptocurrency as a long-term capital play, it can be highly appealing to additionally generate income by loaning their coins—including stablecoins—to lending companies and earning interest. Essentially, these lending companies act as middlemen, borrowing coins from crypto investors and lending them to those seeking to borrow cryptocurrency. Borrowers pay interest (again, in the cryptocurrency in which the loan is denominated), a portion of which is paid to those who lend their coins. The loan space is growing fast, and available products already include collateralized loans, credit cards, and interest-bearing accounts. The returns can be very attractive—far in excess of the returns available on standard deposit accounts or in short-term fiat money markets. However, as we will explore in the next section, these products are not risk-free.
BOX 3
What Is a Crypto Wallet?
In general, cryptocurrency coins are permanently stored on the blockchain that created them. Users access their stored coins through so-called crypto wallets. Crypto wallets are essentially applications that hold users’ public and private key information (PKC). Investors and other cryptocurrency users use these keys to interact with the blockchains that hold their cryptocurrency. Using their private key, an individual can instruct the blockchain to transfer coins from their wallet (or key pair) to another individual’s wallet, identified by their public key. Crypto wallets may take the form of software, such as a mobile phone application, or hardware, such as an encrypted USB drive. Importantly, if a user ever loses access to their wallet or their private key, they permanently and irreversibly lose access to any cryptocurrency associated with their key pair. It is essential that investors keep their wallet information safe.
13 Corporate Finance Institute. Cryptocurrency Exchanges. n.d.
14 CNN Business. What is an NFT? Non-fungible tokens explained. November 10, 2021.
15 NextAdvisor. Want to Buy Crypto? Here’s What to Look for In a Crypto Exchange. October 22, 2021.
16 NBC News. Crypto exchanges keep getting hacked, and there’s little anyone can do. December 17, 2021.
17 Barron’s. Lending Your Crypto Could Generate Attractive Yields. But How Safe Is It? December 12, 2021.
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