By all accounts, 2021 is the year of cryptocurrency. Stories of millionaires being made overnight are not uncommon – causing a collective feeling of intense FOMO all over the world. But, just as the market goes up, so does the collective gasps when it suddenly drops 50%. This has all the makings of a thriller – leaving the spectators and active participants in suspense and questioning if they should buy the dip or wait it out.
While there’s no doubt, digital currencies are a risky and volatile asset, they continue to grow in popularity as another way to achieve diversification and liquidity. However, this asset class needs to be navigated with a combination of caution and strategy.
Before diving in, assess your risk tolerance. Once determined, mapping the market is key. The digital finance ecosystem offers a variety of investment opportunities and tools – each with their own benefits and risks.
Investing directly in cryptocurrencies
The most straightforward approach, but one with arguably more risk, is to invest directly in a coin. While its recent surge to more than $60K in value may be quite enticing to even the most experienced investor, take heed. Bitcoin (and others) can fall in value as quickly as it rises.
Basket of Coins
If the direct investment in crypto makes you nervous, another option is to diversify by investing in a “basket of coins.” This approach includes choosing some or all of the top 10 cryptocurrencies, or creating a diversified mix of some of the larger cryptocurrencies, along with some up-and-coming coins experts believe may have more aggressive upside potential.
Exchange Traded Funds
A more traditional way to invest in cryptocurrencies is to use an exchange-traded fund (ETF). ETF’s are easier to own as they are a standard security and can be bought through any brokerage/investment account and even through your IRAs. However, a crypto ETF has the same volatility and risk as the cryptocurrency it represents, so there’s still no easy ride here.
While there are currently no US-based crypto ETFs, thirteen are already in the approval process with the Securities and Exchange Commission (SEC), and there are several crypto ETFs abroad, including three bitcoin and three Ethereum ETFs in Canada.
ETFs are not the end game. Grayscale is a successful asset manager currently offering Bitcoin and Ethereum trusts. These are traditional publicly traded securities that are accessible through one’s investment, brokerage or IRA accounts.
A crypto hedge fund is like a mutual fund, where a person can invest in a large group of underlying securities. Unlike an ETF, hedge funds are an active asset class and are managed by a team of experts and typically focuse on higher frequency trading for short term gains.
There are plenty of direct-investment options for getting in on the crypto game, but they’re not the only game in town. Investing in the growing, comprehensive blockchain market could potentially have much more promise than just pure-play crypto. In fact, the digital finance ecosystem is growing exponentially – including assets like Non-Fungible Tokens (NFTs), digital securities, Central Bank Digital Currencies (CBDCs) and, of course, Decentralized Finance (DeFi).
Investing in DeFi
DeFi refers to peer-to-peer financial services that permit crypto trading, loans, interest accounts, algorithm-driven cross platform trading and other services. The growth of the DeFi industry accelerated in 2020, growing from $700 million to $13 billion. It reportedly hit $40 billion this year, based on industry data across a host of sources.
One of the ways to invest in DeFi is to trade DeFi assets – tokens representing DeFi networks, applications or protocols. It’s not for the faint of heart since there is also high volatility and risk involved.
Staking is just one more option to achieve passive income based on DeFi. Users lock or hold their funds in a crypto wallet to participate in maintaining the operations of a proof-of-stake based blockchain system, and in return get a pre-defined interest rate. The total amount of cryptocurrency assets staked on DeFi platforms is worth around $21 to $23 billion, as of January 2021.
Yield farming refers to providing liquidity in the form of crypto assets to a decentralized exchange (DEX). The DEX uses this liquidity to execute orders created by token swappers who pay fees. Based on their contribution, yield farmers earn a portion of these fees, which offers additional passive income for your Crypto holdings. Both in the case of staking as in yield farming one needs to be aware of the potential loss of value of the crypto in a liquidity pool as a result of crypto volatility.
DeFi Lending platforms enable users to lend their crypto to someone else and earn interest on the loan. Defi lending can benefit both lenders and borrowers. It offers margin trading options, as well as allows long-term investors to lend assets and earn higher interest rates.
Investing in the Entire Blockchain Ecosystem
After auditing your own personal risk-aversion and your overall investment objectives, you may find investing in the entire blockchain ecosystem is the more “secure” route to take.
It’s important to note that crypto mining profitability is not necessarily tightly correlated to the value changes in cryptocurrencies. You can invest in mining companies’ stocks or mining-related stocks, which might benefit from the increased demand for processing power for crypto mining.
You can also invest in publicly traded blockchain related stocks. Since there are no pure crypto or blockchain stocks, the closest thing will be to invest in publicly traded stocks that have some digital finance exposure, like CoinBase, PayPal, Square, Microstrategy, NVIDIA, or IBM.
To Invest or Not to Invest?
There’s no lack of investment opportunities in the digital finance world. From investing directly in cryptocurrencies, to investing in the comprehensive blockchain ecosystem, individual investors can easily find the right methods that fit their individual needs. But before jumping in, learn more about each of these investment options, understand their risks, and assess how much risk is manageable for you. Just like any investment, taking the time to talk to experts and doing your own research can help you decide the right course of action for you.