Part 2: Cryptocurrencies
TL;DR: Don’t do it.
If you’re the type to read TL;DRs, don’t do it.
Here are the facts/risks:
- The volatility of Bitcoin is approximately 5x that of the S&P 500. Intuitively that means your swings in your cryptocurrency investments will be much bigger.
- There is no clear, measurable basis for the value of cryptocurrencies. Yes, if this thing catches on, it may replace cash as our medium of trade but… How likely is that? How likely will the winning cryptocurrency be Bitcoin or whatever you invest in? How do you even begin to predict the probability of this event?
- Trading is driven by retail investors. Unlike the stock markets, there are many less professional firms keeping cryptocurrency values in check, meaning there could be extended periods of mispricing (and therefore the risk of trading far away from what’s “fair”)
- Fees are high (relative to stocks) to deposit, withdraw, transfer, and trade.
- Taxes are a pain. Be a good citizen, and research how to do them correctly, if you still want to do this.
However, if you’ve considered all that and have read this far, you’ll know there’s more.
Here’s my take: while it’s a very risky investment, and certainly not something to bet your house on, retail-driven and mispriced markets are exactly where financial professionals make their money. It’s a lot of work to get to a point where it becomes passive income, but the following is a guide on getting started to becoming profitable.
Step 0: Know how to invest in it
Before you do anything, you need a place where you could convert your dollars into cryptocurrencies. A good place to start (without needing to give ID for smaller deposits) is Coinbase, where you could link up your bank account. Another popular place to start is Gemini, although you’ll need to give some ID.
Once you have your US dollars in there, pick a coin (whether it’s Bitcoin, Ethereum, etc…) to buy. At the time of writing, because of fees and the speed of transfers, I would recommend Ethereum over Bitcoin.
Then, transfer your cryptocurrencies to a more popular and actively traded exchange such as Binance to start really trading.
Step 1: Give yourself a good framework to think about value
Some people argue you shouldn’t invest in Bitcoin because in a year, it may go to $100k or it may go to 0, and it’s a coin flip which way it goes.
However, in that scenario, Bitcoin should be worth $50k, and I would actually use that as an argument to buy…
Just rethink what you think possible end states for these Cryptocurrencies are and how to calculate the implied price.
Step 2: Think of a good strategy
My personal opinion is that, for me, there is no value in buying and holding; even if markets are inefficiently priced I have no way of discerning in which direction. However, that doesn’t mean there’s no window for opportunity.
A very simple example of a solid strategy is exchange arbitrage. One exchange might price Bitcoin at $6000 where you buy, and another exchange might price Bitcoin at $6005 where you sell. Once you transfer your bitcoin from one exchange to another (to collapse your position), you’re left with a net gain of $5 per Bitcoin (minus fees).
Of course, it’s not exactly that simple, and most of these simple opportunities are gone. However, this is where your creativity comes in – if you can think of a good strategy, this is one of the few places where you can be competitive trading against professionals (due to fees and speed).
Step 3: Program it
The opportunities I see are almost completely in automating your strategies to make them fast (and a form of passive income!). Python is sufficient for most exchanges: and this is where I first learnt the basics for free. You can then Google the APIs for any specific exchange (i.e. the way to hook a computer program up to trade), and start coding!
Step 4: Monitor, Revise, and let the profits roll in
This part’s the good part. After you’ve done the hard work, watch the coins build up in your profile. It’s not simple and takes some hard work, but this is one of the highest profit strategies you could do for your own investments. You can experience some very high success with this even during a period where cryptocurrency values were falling and all your friends are losing.
This is a very new and confusing area to start in, so I’m open to any questions or suggestions on what to expand upon here!
Happy Investing,
TheJKW