Crypto Investing: The Complete Guide (2022)

Crypto Investing: The Complete Guide (2022)

Nansen summarizes everything you need to know for crypto investing

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Introduction

Being new to crypto can often feel like getting lost in an overcrowded city. Shiny signs leading new investors down strange avenues, random people screaming at each other constantly, and anyone can get robbed in a blink of an eye if they stray far enough from well-trod throughways. 

Considering how big the crypto “city” has become in recent years, entering the industry might seem daunting to investors, but it is a sector filled with promise. This article aims to be an introductory map to this chaotic landscape and hopes to provide an unbiased, entry-level guide.

What Exactly is a Cryptocurrency?

Cryptocurrencies are digital currencies based on distributed public ledgers called blockchains. The transactions and ownership record of the currencies are secured using cryptography and virtually held on a network of computers. Since blockchains are distributed systems, the continuity of coordination is of utmost importance, which is reached through different types of consensus mechanisms adopted by the network that accommodates their particular value proposition. 

Proof-of-work (PoW) and proof-of-stake (PoS) are the most well-known consensus mechanisms in the space where the former requires intense computational work to validate transactions and is widely used by the first generation of blockchains (including Bitcoin and Ethereum). Meanwhile, PoS handles block validation through staking native tokens to the network and is used by the overwhelming majority of smart contract platforms (including Ethereum2, Avalanche, and Solana)

The uses of a cryptocurrency can range from the unbound digital space for experimenting with monetary policies to orchestrating coordination on a network through incentives. The first cryptocurrencies based on distributed ledger technologies (led by Bitcoin) focused primarily on providing the functionality of fiat currencies in a decentralized environment. With the introduction of smart contract platforms like Ethereum, the programmability of transactions expanded the scope of instruments secured by blockchains from currencies to other digital assets such as NFTs and fungible tokens. These assets didn’t primarily aim to provide the functions of money (medium of exchange, store of value, unit of account) like the first cryptocurrencies and instead incorporated new ways to interact with value in digital environments.

Those who want a thorough exploration of cryptocurrencies can check MIT’s Blockchain and Money class from Gary Gensler, the current chairperson of SEC. And those who want to dive deeper into the technical foundations of blockchains and cryptocurrencies will benefit from following Tim Roughgarden’s Foundations of Blockchains series.

How to Invest in Crypto?

Onboarding to crypto got dramatically easier in recent years as the industry left the edges of the fringe and joined the mainstream. Investors can sign up to a centralized exchange and purchase from a broad range of assets in just a few clicks, and proceed to the platform as a bridge between the off-chain and on-chain worlds. Although how people join the industry can change depending on the motives for participating in crypto, the first onboarding of the funds is almost always the same for a regular investor. Here is what this journey typically looks like:

Choosing an Exchange

The best gateway to crypto can be different for every investor depending on the assets they want to purchase, why they are signing up for the exchange (e.g. storing assets, daily trading, or as a step to the on-chain world), their KYC preferences, and the jurisdiction they live in.

Among dozens of centralized exchanges in the industry, the well-established ones tend to have a large user base and a global outreach, offer a broad range of markets and have deep liquidity on major pairs. Binance, Coinbase, Huobi, Kraken, Crypto.com, FTX, and Gemini are some of the biggest names in the market, each offering different products and allowing withdrawals to different sets of blockchains. Alternatively, investors can choose direct on-ramping platforms like Moonpay and start trading crypto without having an account on a centralized exchange.

Sign Up and Verify

Upon choosing and signing up for an exchange, an investor will need to verify their identity following the instructions provided by the exchange. Through the verification process, the anonymity of crypto turns into pseudonymity. Any on-chain activity an investor will do on non-private public ledgers can be tracked down to their exchange address.

After the verification is complete, investors can buy, store, or transfer their crypto assets outside of the exchange. Yet there is often a limit on the daily withdrawal amount that would need additional verification processes (e.g. Binance has three verification tiers: Verified, Verified Plus, and Enterprise Verification)

Store in a Wallet

When it comes to storing the purchased assets, self-custody is often preached to make sure participants are aligned with the main ethos of crypto. “Not your keys, not your coins” is an expression frequently used to point out the implications of centralized exchanges managing private keys for the investors.  The consistency of this message makes sense considering how there have been several bleak incidents where centralized exchanges siphoned user funds out of the platform or even allowed users to trade assets that are simply not there. That’s why it’s a good mental model for investors to treat funds on centralized exchanges as 1:1 redeemable synthetic representations of these assets rather than the assets themselves, allowing them to acknowledge the risks of censorship and loss of funds.

However, even though self-custody is an idealistic path that allows investors to enjoy the freedom of taking the reins on their financials, it also comes with a price. Increased responsibility, full accountability, and risks inherent to the industry such as smart contract vulnerabilities, exploits, phishing attacks, and loss of funds due to poor private key management can make this choice far from optimal for an investor. Therefore, those who want to get exposure to assets but are hesitant to interact natively with cryptocurrencies often use centralized exchanges not as a necessary bridge to the on-chain world but as a custody solution.

Apart from centralized exchanges, the non-custodial solution is to use crypto wallets.

Hot wallets: These are most suited for investors who favor speed and efficiency over security. Metamask (Ethereum and EVM chains), Keplr (Cosmos Chains), Phantom (Solana), Argent X, XDeFi, and other browser wallets are considered hot wallets since they are connected to the Internet and designed for fast-paced regular use. Unlike the most popular cold storage solutions (excluding paper wallets), hot wallets are completely free, easy for investors to get their hands on, and more convenient for trading than long-term investing. 

Cold wallets: The ease of use provided by hot wallets is a double-edged sword. Investors who plan to hold significant amounts on the chain or favor security over ease of use regardless of the size of their investments are better off using cold wallets like Ledger and Trezor. While hot wallets store private keys digitally, cold wallets are essentially physical solutions that keep investors’ keys in an offline environment, making them extra resilient against potential attack vectors. There are a couple of things an investor needs to consider when choosing a cold wallet. Supported currencies, security, portability, and platform compatibility are some of these features.

Most Popular Cryptocurrencies for Investment Purposes

It's only common sense that an asset being popular doesn’t necessarily translate into it being a viable investment, especially if the popularity has only been tested in a limited timeframe. Blockchains with ambitious dreams, DeFi applications attracting liquidity through their charismatic leaders, and countless projects that were once dearest of participants and occupied the stage for a while eventually lost steam and left the scene without being able to live up to expectations. That’s why assessing popularity throughout a larger timeframe is one of the best way to hedge.

Change of popularity becomes much clearer when we compare the top 20 coins in 2017 by market cap with the current rankings

Market cap, number of holders, and total value secured through the platform can all be indicators of popularity. Since all the others are in a reflexive relationship with the former at some level, the market cap is a useful metric to get an opinion on the performance of the asset. Yet it is far from a perfect indicator as market caps in crypto are still not driven by tangible value but by expectations of future adoption. Cardano in 2021 is a fitting example of this dissonance where investors put their money into a highly popular technology that wasn’t able to live up to expectations, showing high market caps can be just a reflection of very good optics.

Therefore, instead of a list of cryptocurrencies with the highest market, here is a list of the most popular categories and some of the most popular assets from these categories for investment purposes.

Bitcoin (Currency Chains)

As the first decentralized cryptocurrency, Bitcoin proved itself in the last fourteen years as a functioning payment network that operates outside the control of a central authority. Favoring stability with a hard cap on total supply, security with cryptography, and maximum decentralization with technical design choices like small block sizes, it is designed to be resilient against censorship and to facilitate participation, which led the network to witness broad global adoption as non-sovereign money.

Bitcoin uses a proof-of-work consensus mechanism to secure its database and rewards those who ensure the validity of transactions with fresh-minted bitcoins (see: mining). This self-sustaining system allowed Bitcoin to maintain functionality even in atrocious market downturns as it created a dynamic balance between supply and demand for services. Currently, the currency has the highest market cap in the industry and is generally regarded as the safest option to bet on the future of cryptocurrencies.

A few other examples of currency blockchains (chains with value propositions limited to being payment networks): Bitcoin Cash, Dogecoin, eCash, Litecoin, and Ripple.

Ethereum (Smart Contract Platforms)

Launched in 2015, Ethereum remains to be the most used smart contract platform on the market. While its predecessor, Bitcoin, supported simple state transitions, Ethereum used the technology to create a programmable transactional network, giving way to a wide set of use cases such as DeFi, NFTs, and fungible tokens which relied on a different level of complexity.

Ethereum also started as a proof-of-work blockchain that required miners to do computational work and in exchange rewarded them by minting native tokens (i.e. ether) Yet the chain will soon adopt the proof-of-stake consensus mechanism as a more sustainable alternative and eliminate the intense computational input necessary to validate transactions (see: The Merge).

With a vibrant economy built on top, Ethereum hosts the largest ecosystem among smart contract platforms and has the second largest market cap in the industry after Bitcoin.

A few other examples of smart contract platforms: Avalanche, BNB Chain, Cosmos Hub, Polkadot, Polygon, and Solana.

Monero (Privacy Coins)

We mentioned how the transparency of public ledgers and the traceability of transactions turn the seemingly anonymous accounts into pseudonymous as the transactions can often be linked to identities on exchanges. Privacy coins like Monero aim to obfuscate transaction details (i.e. transacting parties and the amount transacted) and bring back the anonymity to public blockchains and prevent mass financial surveillance.

Monero is the largest privacy coin by market cap, followed by Zcash. While these two currencies aim to provide Bitcoin’s value proposition in a privacy-enabling environment, there are also privacy-focused blockchains like Oasis Network and Secret Network and application-level solutions like Aztec that want to bring privacy to smart contract platforms.

Arweave (Decentralized Infrastructure)

Arweave, a decentralized storage solution that allows data to be stored permanently, is one of many decentralized infrastructure projects that adopt blockchain as a tool for coordination and cryptocurrencies as an incentivization mechanism. By paying a one-time fee using Arweave’s token AR to storage providers (a.k.a miners), users can access lifetime storage on Arweave where the permanency of data is assured through the redundancy provided by blockchains (to be more precise, through blockweave, a derivative of blockchains).

Storage solutions like Arweave and Filecoin, cloud services like Akash Network, wireless infrastructure like Helium, and P2P file sharing networks like Bittorrent are some of the decentralized infrastructure providers market participants can invest in through crypto.

Aave (DeFi)

Decentralized finance is a vast landscape of financial services that span multiple chains. Aave is one of the largest decentralized money markets that fully operates on-chain via smart contracts and offers permissionless lending and borrowing services to market participants. Like all the most popular DeFi applications, Aave was first introduced on Ethereum before expanding to other EVM chains and still hosts the most liquidity on Ethereum.

Aave’s fungible token AAVE is essentially used for governing the application and incentivizing users. It doesn’t play an essential role in its operations as ether plays in the Ethereum network.

Investing in application tokens has been a controversial topic in DeFi due to applications rarely using their tokens for their core operations and side benefits like revenue sharing not justifying the high prices of the tokens. And since tokens didn’t entail a legal liability like stocks in a company, the lack of utility wasn’t compensated with tangible ownership and turned tokens into more donations receipts with speculative purposes rather than equities.

However, the implications of this discussion are beyond DeFi tokens and encompass all crypto projects with fungible tokens. Besides, more and more projects started engineering their tokenomics to incorporate tokens into their core operations (see: Curve Finance), allowing the asset to capture the financial value from the provided services.

A few other examples of DeFi services: Uniswap, MakerDAO, dYdX, Compound Finance, and Lido.

The Sandbox (Metaverse)

The internet of money increasingly turning to the money of the internet allowed metaverse projects and games to build their economies on an open and interoperable financial infrastructure (e.g. Ethereum) Sandbox is one of the major projects providing virtual worlds for players to create and monetize their experiences where their token SAND is used as the currency for microtransactions in the game and as the governance token for the platform.

A few other examples of metaverse & games using crypto: Decentraland, Axie Infinity, Gala Games, Illuvium.

CryptoPunks (NFTs)

Some see NFTs as a major cultural shift (see: crypto renaissance), some as a bet on the attention economy, and some as the peak manic phase of a speculative bubble. Use cases for non-fungible tokens are not limited to being decentralized proof-of-ownerships for digital pictures. Nonetheless, this niche use case has been the place where market participants would find most of the investment opportunities.

CryptoPunks is one of the first collections that used NFTs to introduce artificial scarcity to unique digital art pieces and gained quite the success in a few years. Although most investors would be priced out of this particular asset, the NFT space is full of new opportunities.

Investors willing to dip their toes into NFTs are highly encouraged to check the articles we previously wrote about the things to look out for when investing in NFTs and the analytics tools to use to find the best opportunities in the market.

A few other examples of NFTs (collections): BAYC, Doodles, Ethereum Name Service, Forgotten Runes Wizard Cult, and Pudgy Penguins.

How to Choose the Right Investment

There are certain investing frameworks in crypto that are widely beneficial for market participants no matter their expectations and risk tolerance. Although some outliers made profits despite deploying ill-advised strategies like following influencers blindly, it’s definitely not a common occurrence, and those who don’t overestimate their luck and acknowledge how slim the probability is for exceptional returns are better off following basic frameworks for a healthier approach to investing.

Researching the Right Way

The lack of regulation and investment protection in the markets combined with self-custody of the funds naturally increases the responsibility that the average market participant need to shoulder. Hence the expression DYOR (do your own research) is frequently invoked in crypto.

Every idea presented on social media, every piece of information provided by projects, glorious comments from influencers, fund managers, or even regular Joes should be analyzed with deep scrutiny. Everyone is a potential opponent in the investment game, and even if they are not, this type of prejudicial vigilance and the individual reasoning that comes with it has proven to be the key to survival in crypto markets.

The following are some fundamental areas investors can focus on while doing their own research.

Performance Metrics

The latest crypto bull run showed us that performance metrics in bubbles are mostly used as canvases for narrative creation and to boost the speculative pump of an asset. However, when the dust settles and everyone can see who is swimming naked, they become highly relevant for the long-term sustainability and success of a project.

The number of users, financial value secured on the platform, revenue for the service providers, treasury health, platform traffic, business-side adoption, distribution of the holders, and market cap are some of the metrics to be monitored when considering investing in a blockchain. DeFi, decentralized infrastructure, DAOs, and NFTs have their own metrics both similar to and diverging from those mentioned above.

To learn more about the performance indicators, check the extensive guide from the Nansen Alpha team on things to look out for when investing in crypto.

Check the Chain

A public ledger means that all the information is readily available on a transparent database. Although some agents prefer using centralized exchanges as a more private solution, since most of the tokens are not on centralized exchanges decentralized finance platforms provide opportunities that cannot be interacted via accounts held on centralized exchanges, and the NFT space thrives on decentralized markets, the meat of the crypto activity can be monitored checking the chain.

However, this data can be overwhelming sometimes. Nansen presents on-chain data to its users in real-time and allows them to navigate the on-chain world by watching the smartest investor in the space, explore the multichain world, and level up their crypto and NFT investment game with its industry-leading analytics toolkit.

Want to see how Smart Money is investing? Sign up for a Nansen plan today!

Promise Delivery

The importance of vision in nascent technologies can sometimes make the techno-optimist and the FOMO-driven investor neglect the actual execution of the vision. Yet for any crypto project with elaborate roadmaps, the materialization of plans and the impact of the milestones achieving this vision is highly crucial.

There are countless examples of blockchains, NFT projects, DeFi apps, or decentralized infrastructure boosting the expectations with undeserved hype, not delivering on time, and leaving investors with mass disillusionment.

People: Team, Community, and Investors

Crypto is the most transparent place in the investing space for monitoring how participants behave. The competency of a team is often challenged through on-chain problems and governance proposals where most of the relevant discourse about a project is often held in public.

Anonymity is a tricky issue in assessing teams. Not knowing certain team members and investors can be off-putting at first. Yet it's better to treat the phenomenon as a neutral thing. Some of the worst scams are done by doxed individuals while the majority of the cypherpunk community, including Satoshi, were anonymous, showing how a sophisticated community with aligned values can give way to revolutionary results despite not revealing their identities. 

When it comes to evaluating founders, the rule of thumb is to remember that no one person gives a definite green light to a project, although some can be an absolute red flags.

Technology and Economics are Two Different Things

Solid technology, consistent delivery, and even increasing adoption cannot promise an appreciation in asset price if the generated value doesn’t accrue to the currency or if the project has bad tokenomics in the first place (see: Defining Good and Bad Project Tokenomics)

There are countless instances in crypto where a project has steadily increased in key metrics while the token flounders, and vice-versa. Unlike in stocks where performance is often directly tied to price, in crypto it is not always a clear-cut line.

Know Crypto-Related Risks

Apart from the high volatility and macro risks already present in the stock market, crypto welcomes investors with some endemic risks that any participant should be aware of when choosing an investment. Smart contract risks, exchange hacks, phishing attempts, scams, frontend exploits, governance exploits, and even attacks at the consensus level are some of the risks investors need to take into account before choosing an investment.

On top of that, the lack of accountability and the immutable nature of blockchains (i.e. irreversible transactions) require investors to actively monitor their assets for these risks. Especially if the projects they invested in tend to choose innovation and experimentation (e.g. DeFi apps) over stability and security (e.g. Bitcoin) and thus are prone to new attack vectors with every new update.

FOMO is the Mind-Killer

The freedom in the industry allows investing in anything available on the market, from the best to the worst. When this freedom is accompanied by a highly social aspect of crypto investing, market participants encounter countless moments where they feel like they finally caught the next big thing and experience an emotional urge to ape into an investment before the door for opportunity closes (FOMO).

This often results unfavorable for the investor as it puts reasoning on hold and causes emotional investment. Sticking with an analysis framework and finding ways to avoid groupthink can help with FOMO.

Avoid These 5 Biases

Unit Bias: When investors make assessments on whether an asset is expensive or cheap based on the unit price rather than its market cap, they fall into the unit bias. This bias pushes investors to think it’s more favorable to hold one million units of a meme token with an astronomical token supply instead of a fraction of a more “expensive” coin due to a more concrete feeling of ownership (i.e. buying 1m of a token instead of 0.1 of another) Not the price but the market cap is the more accurate way of comparing potential investments based on their valuations and investors should know that they can always own a fraction of these assets.

Here is an example of unit bias.

Sunk Cost Fallacy: Also known as bagholding, sunk cost fallacy is when an investor with an invalidated thesis doesn’t want to part with their holdings because there is too much time spent holding the asset or the asset already losing its value giving the impression that the downside is limited. Yet many experienced investors from previous crypto cycles witnessed their investments going 90% down just to see them fall off the cliff, going down another 90%.

Endowment Effect: Another type of emotional bias that breeds frustrated bagholders is the endowment effect. When an investor gets emotionally attached to their holdings, which is quite prevalent in crypto with the presence of a community making an asset a part of their social identity, they start filtering out negative parts and overestimate the positive ones, resulting in irrational decision-making and attachment.

Survivorship Bias: The number of people who made impressive returns from investing in crypto is quite small compared to the number of people who walked away with a regrettable net loss. Focusing on the winners and neglecting the silent majority (losers) may make an investor miscalculate risks and overestimate their probability of success.

Hindsight Bias: This bias is more of self-imposed psychological torture than a cognitive pitfall that directly costs investors money. It happens when an investor retroactively assigns greater predictability to an event after its occurrence. If someone often finds themselves saying things like “I knew this was a sucker’s rally, I should have sold it in the first place!”, they might be suffering from hindsight bias.

Other Ways to Make Money Using the Technology

The crypto economy (DeFi and CeFi) is ripe with passive income generation opportunities. They introduce productivity to idle investments through yield farming activities which can be summarized under three broad categories: staking, lending, and providing liquidity.

Staking is locking up native tokens on proof-of-stake networks to contribute to chain security or fungible tokens on smart contract applications to show long-term alignment with the project. Staking offers stable income on speculative assets (i.e. coins other than stablecoins) and is a relatively safe choice to generate income while maintaining exposure to the asset. Staking Ethereum’s native token, ether, is one of the most favored choices in this category. Investors who hold ether can explore this strategy through our complete guide to staking ether and start earning a healthy APR on their assets.

Lending is conceptually similar to lending in traditional finance and consists of depositing assets to decentralized money markets or CeFi lending platforms to generate income through loans. Aave, Compound, and MakerDAO are among the top decentralized crypto lending platforms on the market. See our complete guide on lending to explore the fundamentals of crypto lending and know more about the well-known lending platforms on the market.

Providing liquidity is depositing assets to pools in decentralized exchanges like Uniswap, Sushiswap, and Balancer to increase the liquidity of the pool and gain a share of the trading fees as a reward. While staking and lending are available for a limited number of assets, an investor can provide liquidity for almost every fungible asset they have as long as the asset is traded on a decentralized exchange. Therefore, providing liquidity is the most available option for long-tail assets.

Investors who are willing to learn more about the passive income generation opportunities in the market can check our comprehensive guide to yield farming strategies and our guide on yield farming with stablecoins to find out relatively safer strategies.

Mini FAQ

What is the best cryptocurrency for beginners?

There are a few good options for traders and investors getting started in cryptocurrency. Bitcoin is the most battle-tested speculative crypto asset in the market. Meanwhile, Ethereum hosts the most activity and services in the space, making Ether the best choice for those willing to explore the diverse use cases of crypto like NFTs and DeFi and bet on their future. Stablecoins like USDT and USDC are best suited for those willing to store funds and interact with DeFi without the risk of volatility. These three options could make a good starting point, but each investor should DYOR. 

Do you have to pay taxes on your crypto?

Not every jurisdiction introduced a tax on crypto investing. Some countries like the USA, the UK, and Canada treat cryptocurrencies as assets and impose taxes while others either bring conditionality to taxing or don’t tax crypto at all. To learn more thoroughly about the global state of crypto taxing, check PwC’s Annual Global Crypto Tax Report 2021.

Conclusion

Although this article should have equipped the investor with an overall introduction to the crypto investing landscape, it's actually only the tip of an ever-expanding iceberg. Crypto never sleeps and never stops. Check Nansen’s resource portal and subscribe to our newsletter to keep yourself up to date with the market.

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