Cryptocurrency Buying & Selling
What to Know About Investing in Crypto Exchanges
A conversation with cryptocurrency expert Ethan Vera
By Jim Probasco
Jim Probasco has 30+ years of experience writing for online, print, radio, and television media, including PBS. His expertise includes government programs and policy, retirement planning, insurance, family finance, home ownership and loans. He has a bachelor's from Ohio University and Master's from Wright State University in music education.
Reviewed by Chip Stapleton
Chip Stapleton is a Series 7 and Series 66 license holder, CFA Level 1 exam holder, and currently holds a Life, Accident, and Health License in Indiana. He has 8 years experience in finance, from financial planning and wealth management to corporate finance and FP&A.
Fact-checked by Timothy Li
Timothy Li is a consultant, accountant, and finance manager with an MBA from USC and over 15 years of corporate finance experience. Timothy has helped provide CEOs and CFOs with deep-dive analytics, providing beautiful stories behind the numbers, graphs, and financial models.
Learn about our editorial policies
Updated November 17, 2024
Reviewed by Chip Stapleton
Fact-checked by Timothy Li
For those relatively new to investing, crypto can seem daunting, even downright scary. Cryptocurrency is a decentralized digital or virtual currency secured by cryptography. Some of them are limited in supply, which helps give them value and makes them nearly impossible to counterfeit or double-spend.
Today, most buying and selling of cryptocurrency takes place through a cryptocurrency exchange, much like a stock exchange for securities. An exchange is an intermediary between a buyer and a seller of Bitcoin, the most well-known cryptocurrency, or any other type of cryptocurrency.
To help remove some of the mystery surrounding cryptocurrencies as an investment, EstHive spoke with Ethan Vera, co-founder of Luxor and Viridi Funds as well as a member of EstHive’s Financial Review Board. Vera’s expertise in cryptocurrency and crypto mining stems from his immense experience in the space. EstHive spoke with Vera about crypto in general and how to access cryptocurrency as an investment. Our edited conversation follows.
Warning
Although legitimate cryptocurrencies can offer solid returns, investors must be very cautious. The Federal Bureau of Investigation found that in 2023, investment fraud was the most reported cryptocurrency fraud, while the amount of losses from crypto fraud for the year totaled $5.6 billion.Key Takeaways
- Many investors use Bitcoin as an inflationary hedge and an excellent long-term investment.
- Major and centralized exchanges are heavily regulated, making them much safer for new investors.
- A common mantra is never to invest more than you can afford to lose, while other investors recommend 2% to 3% of your portfolio.
- Exchanges have excellent support systems that can be relied on by investors.
- Taxes must be considered when using cryptocurrency because, like all investments, capital gains taxes apply.
Reasons to Invest in Crypto
EstHive: First, what makes cryptocurrency a good investment?
Vera:
Let’s start with an example. In terms of investing, among cryptocurrencies, Bitcoin is the most stable and least volatile digital currency. It should be thought of in a similar manner to a long-term equity investment, not like fixed income. In that respect, Bitcoin is similar to a large-cap stock. Of interest these days, Bitcoin is considered an excellent inflationary hedge. As a commodity, Bitcoin is the most regulated cryptocurrency and the least risky, since Bitcoin’s protocols limit risk.EstHive:
Aside from Bitcoin, what are some other cryptocurrencies, and what makes them worth considering?Vera:
The Ethereum blockchain network and its cryptocurrency, Ether, are popular because of the applications being built on top of it. Uniswap and Solana are other exchange and protocols gaining significant volume. Many altcoins, meaning cryptocurrencies other than Bitcoin, function as more of a technology play. Their innovations are really interesting; however, sometimes this is at the expense of decentralized governance.The Danger of a 51% Attack
EstHive:
What do you mean by disruption?Vera:
One type is a hypothetical, for now, disruption known as a 51% attack. A 51% attack is when a group of miners controlling more than 50% of a network’s mining hash rate or computing power could prevent new transactions, reverse transactions, and double-spend coins. While it might not destroy the system, it could cause a lot of damage.Obviously, the best way to prevent a 51% attack is to make sure nobody controls more than 50%. In Bitcoin mining, the cost and difficulty of hardware and energy procurement make this very unlikely. The network is very resilient to this type of attack.
The Role of an Exchange
First of all, the major centralized exchanges, like Coinbase, Kraken, and others, are heavily regulated. The first thing to know before choosing an exchange for investors is to check if it can legally operate in your jurisdiction. Even with well-regulated legal exchanges, don’t put all of your investment in one exchange at the same time. In other words, spread out your investments and hold as much as possible in cold storage. There are many bad actors in crypto, and the best way to avoid them is to deal with well-known regulated exchanges, your own wallets, and trusted custodians.
Centralized vs. Decentralized
Centralized exchanges, like Coinbase, are regulated, easy to use, reliable, and allow trading of digital for fiat currencies (i.e., dollars). However, they require you to trust your counterparty. Decentralized exchanges are controlled by the users, sometimes at the expense of user experience. Newcomers to crypto should start with centralized exchanges, due to the ease of use, and then experiment with decentralized ones.
Level of Involvement
First, what percent of my portfolio do I want to allocate to cryptocurrency? It should be some, but certainly not an overwhelming amount. The best answer is “not more than you can afford to lose.” Many experts suggest that no more than 2%–3% of your portfolio should be allocated to cryptocurrency.
Where to Get Help
Most major exchanges offer very good support for investors, including advice. Any reputable exchange has a good support network and can help even the most novice investors. It’s important to do research on your own and not pay for consulting from unknown sources.
FAQs
What’s the Difference Between a Centralized and Decentralized Crypto Exchange? According to crypto expert Ethan Vera, centralized exchanges like Coinbase are regulated, easy to use, reliable, and allow trading of digital for fiat currencies (i.e., dollars). Decentralized exchanges are anonymous and less prone to hacking, but they don’t let you trade for fiat and are complicated.
What Percentage of My Portfolio Should Be in Crypto? Vera says the best answer is “not more than you can afford to lose.” Beyond that, most experts suggest it should be less than 5%, along the lines of 2%–3%.
What’s a 51% Attack? A 51% attack in the crypto world is a hypothetical type of disruption in which a group of miners control more than 50% of a network’s mining hash rate or computing power. In such a scenario, they could prevent new transactions, reverse transactions, and double-spend coins. It might not destroy the system, but it could cause a lot of damage.
Closing Thoughts
Keep in mind that like any type of investing, with crypto, the higher the potential reward, the riskier the investment. This is the reason for keeping your investment in crypto manageable, sticking with trusted exchanges, and getting as much education as possible, no matter your level of involvement. Another important concern is taxes. You need to know your tax obligations when it comes to cryptocurrency, especially when working with a well-regulated centralized exchange. It’s important that you report all realized capital gains just as you would with any type of investment.
