Bitcoin investing used to be quite simple; just buy & hold. This is not the case anymore in 2020. There are many other ways to have exposure to cryptocurrencies. It’s also possible to earn money when the market is going down. In this article, we’ll go through the pros and cons of different investing methods. We are mostly talking about Bitcoin, but these methods are already available for the most popular altcoins too (especially Ethereum).
Traditional cryptocurrency investing
Let’s start with the basics. Back in the early days, there weren’t many options for Bitcoin investors. You simply bought bitcoins and then you kept them in your wallet and hoped the price would go up. This is also called the buy & hold method, which many people do with stocks.
After the initial purchase, bitcoins are stored in a Bitcoin wallet (recommended) or in an exchange (not recommended). In this example, your coins are no different from gold and silver coins or dollars in your pocket. You don’t get any yearly interest. You just “HODL”.
For a long time, this was the only way to invest in cryptocurrencies. The most popular exchanges, especially ones for newbies, had also just Bitcoin or 1-2 different altcoins. Even Coinbase had just Bitcoin, Litecoin and Ethereum until December 2017. They really started to expand to altcoins in 2018-2019.
The buy & hold method is still the most common one. It’s also very often the method of purchasing your first cryptocurrencies. Even if there are more advanced methods available, there is a good reason why buy & hold is still so popular. Let’s check the pros and cons.
- Easy and simple, this method is for everyone.
- No need to learn the functionality of complicated instruments.
- The low-risk option, if executed correctly.
- You can use the most reliable, established sites.
- You have the responsibility of storing your cryptos safely.
- The safest storage options (Trezor, Ledger Nano) require some technical skills.
- A Bitcoin on your Coinbase account doesn’t give you any yield.
- You can only make a profit if the market is going up.
Check these popular exchanges for buying & holding cryptos.
Derivatives trading in cryptocurrency exchanges
The global derivatives market is massive. It’s no surprise, that they’ve become available for cryptocurrency investors too. The crypto derivatives market was quite small during the previous boom in 2017, but the situation has changed a lot since.
Derivatives are very popular instruments in the traditional finance world. They are products, which derive their value from the underlying asset price. For example, if the gold spot price goes up, the price for the gold futures goes up as well.
The most common derivatives are options and futures. Lately, CFDs (Contracts For Differences) have also become widely adopted.
We can split the crypto derivatives market into two: cryptocurrency exchanges and other online trading platforms, which have added cryptocurrencies to their offers in the past few years. In cryptocurrency exchanges, trading is mostly done through Bitcoin. You deposit cryptos in and withdraw cryptos out.
When you are playing derivatives, you are trading. The difference is that holdings in trading are usually kept from few minutes to a few weeks. Trading by nature is all about high-frequency decisions while investing is buying something and holding it for years or even decades.
Another difference is the possibility to use leverage. Currently, you can leverage your trades up to 100:1 or even 150:1 in some cases. The third major difference is the possibility to short sell, which means you can make money when the market is going down.
Derivative trading is not recommended for amateurs. It has higher risks due to leverage and the rules of the derivatives are more complicated to understand. The reward is equally higher, though.
Here are the pros and cons of the derivative trading in cryptocurrency exchanges.
- Anyone can start trading derivatives with leverage easily and quickly.
- Leveraged trading makes huge gains possible.
- Shorting makes it possible to make money when the market goes down.
- Derivative trading is not suitable for beginners.
- The downside of leverage is the chance to lose money fast.
- Derivative trading might be taxed more harshly than normal buying & selling.
Check these popular exchanges for buying & holding cryptos.
Derivatives trading in other trading platforms
In the previous chapter, we explained derivates trading in cryptocurrency exchanges. The industry pioneers like BitMEX have indeed become very popular. Other exchanges, like Binance, have also started to offer futures lately.
The cryptocurrency trading is not just done in cryptocurrency exchanges. The most popular trading platforms have made cryptocurrencies available in the past few years due to increasing demand. The best-known of such platforms is eToro.
Trading derivatives at BitMEX or eToro is not that different by nature, but there is one very significant feature you must know. You can invest in cryptocurrencies at eToro without ever owning one single coin yourself!
You make a deposit with euros (or other fiat currencies) and you withdraw fiat currency as well. You don’t have a crypto wallet and you never own any coins. All trading is done with CFDs.
This option has become increasingly popular among traditional investors, who have so far invested in stocks, ETFs and other instruments like that. These traders want to have some crypto exposure without having to worry about storage or hacks or any other threats.
The pros and cons are pretty much the same as described in the previous chapter. Trading without owing cryptos is either a positive or negative thing, depending on your view.
Probably the best feature of derivates is shorting. This gives you a possibility to cover (hedge) your crypto portfolio against negative market movements without having to sell your coins! This is significant because selling triggers a taxable event. Instead, you can create a short position on the market and cover your losses (or some portion of them) with this trade instead.
Check these popular investing platforms for crypto derivative trading:
Bitcoin ETN tracker or Bitcoin ETF
We have so far covered two different ways to invest in cryptocurrencies: buy & hold and derivatives trading. There is also an interesting option, which lies in the middle.
Let’s say you are a traditional investor with stocks and ETFs on your portfolio. Now you decide to be brave and invest 5% of your portfolio into Bitcoin. However, you are a bit afraid of hacks and you are not technically skilled to use hardware wallets. You also just want to buy & hold so you don’t need any derivatives.
We are using an example from Scandinavia, but there are similar products in other countries as well. Scandinavian trading platform Nordnet offers XBT Provider’s ETN tracker for Bitcoin and Ethereum, which works like an ETF.
If you don’t know how ETF works, here is a simple example. Let’s say you have an ETF called S&P 500. This means that the fund is investing in the 500 biggest companies in the US. If this portfolio goes up, the value of the ETF goes up the same way. Such an ETF gives you a very effective way to buy a small fraction of the market
The Bitcoin ETN tracker moves up and down when Bitcoin’s price moves up and down. Your investment changes in value as you’d have bitcoins on your Coinbase account. In the future, there will be lots of different crypto ETF funds available.
Investing in Bitcoin through such a product has a significant difference in derivatives trading. You can buy such a product as a part of your standard stock portfolio, which makes it very easy from the tax point of view (Note: each country has different tax laws, check yours).
The downside is there is no short selling for such a product. You are also limited to the opening hours of the exchange where this product is listed. This might cost you, especially on weekends or longer holiday periods, because the underlying crypto market is open 24/7.
Let’s check the pros and cons.
- You can invest easily in Bitcoin without having to worry about owning it yourself.
- Trading is easy and it can be done in trusted platforms.
- You have stocks, ETFs and other financial products on the same platform.
- Easy for taxes (depends on the country, though).
- Trading is only available when the stock exchange is open (note weekends, holidays).
- You can only make money when the market is going up.
- Since you don’t own the cryptocurrency yourself, you might be in trouble if there is a banking crisis
- Usually just Bitcoin or Ethereum available (again, depends on the stock market you have available)
If you are Scandinavian, check out Nordnet!
Last, but not least, we’ll introduce a new form of investing. This has become increasingly popular since the rise of DeFi – Decentraliced Finance. We are talking about lending services now.
As the name suggests, the idea is to lend your cryptocurrency to another entity for a fee. The market average is about 5-8% yearly interest, which might not sound a lot to crypto investors. This is the average profit you can expect from the traditional stock market in the long run.
Hence, crypto lending is a very interesting option, especially for institutional investors. You can also convert your fiat savings into USD-based stablecoins and earn even more interest. Nowadays banks pay barely any interest even for savings accounts. There are already negative interest rates introduced.
You can change your fiat (EUR, USD, etc.) into USDT (Tether) or similar stablecoins and then lend this cryptocurrency through a service like BlockFi. It’s basically no different than holding US dollars in your bank account. If your funds are in other fiat currency, like EUR, there is, of course, a risk from exchange rate fluctuations. This could also work in your benefit, though.
The only major question mark is the whole niche. These services haven’t been around for a long time, so it might be difficult for the user to estimate the risk. Sure, the yearly interest rate is nice but what risk are you carrying with it? We haven’t seen any major DeFi bankruptcies so far.
Let’s check out the pros and cons.
- You can earn interest on your crypto investment, which will boost your gains further. Even if the whole market goes sideways, you still earn something.
- You can also convert your fiat savings into stablecoins for increased income.
- The compounding interest makes wonders over the years.
- You’ll only get the whole benefit when lending (=locking) your crypto for the whole year, which makes them unavailable for trading elsewhere.
- When owning cryptocurrency, you must take responsibility for storing it properly.
- Can you trust the DeFi operators yet to make a big enough deposit?
Check these popular options for lending your cryptos.
Cryptocurrency investing has changed a lot in the past few years. It is much more than just “hodling” your precious coins. The derivatives market is growing fast and giving fresh options for crypto investors. Now you can also protect your portfolio from market crashes and even make money when Bitcoin price is going down.
There is an increasingly growing group of investors, who want to be part of the market without having to worry about storing, exchanges, hackers, etc. Even if hardware wallets like Trezor are very user-friendly, they do need some skills, maintenance, and care for backup codes.
In general, it’s great that the whole market is growing, and new opportunities are out there. This draws in more traditional investors, who aren’t interested in holding the bitcoins in a wallet for five years.
Shorting (with leverage) is also a good option for those, who think Bitcoin is a bubble and the whole market is going to crash. These haters can now put their money where their mouth is and just short it!
Everyone should choose the form of investing, which feels comfortable. Safe and easy usually equals lower profits as well. If you want to win big, you must take risks as well and recognize them beforehand.
Check also your local tax laws before trading derivatives. Make sure you know if there is a difference between traditional buying & selling and using CFDs and futures.