Before throwing your capital into the best performing asset class of the last decade, you need to understand that purchasing, holding, and trading cryptocurrencies is very different from doing so with traditional assets like stocks, bonds, or mutual funds.
Entering the Cryptocurrency Ecosystem
In the world of cryptocurrencies, “fiat” is the word used for government issued money like US dollars, and the first step for entering the cryptocurrency ecosystem is to exchange your fiat for crypto.
Most people enter the crypto ecosystem by buying bitcoin, as it has the most widely available options for purchase, and almost every other cryptocurrency is paired with it. This means that once you have bitcoin, you can easily trade it for any other crypto.
The vast majority of crypto purchases and trades nowadays occur on centralized exchanges and though over the counter (OTC) desks, but you should know that cryptocurrencies can be purchased in several other ways.
A Word about Anonymity
It should be stressed here that the Bitcoin network is a public ledger of transactions. This means that if your identity is attached to a bitcoin address, it’s a trivial matter for governments to track your every trade.
Of course, Bitcoin is also considered a pseudo-anonymous cryptocurrency, so if it is purchased and sold anonymously, it’s possible for the holder to remain hidden throughout the process.
Whether or not to remain anonymous is the main factor that should inform the method you choose to purchase bitcoin.
Libertarians argue that Bitcoin and other cryptocurrencies, as money, should remain anonymous for their users. Governments, they say, have no business monitoring the everyday purchases of their citizens.
Regardless of your views on the legality of anonymous transactions, the trading of bitcoin and other cryptocurrencies has tax implications, and these vary by country.
In some countries, you are only open to taxation when you “cash-out,” meaning when you exchange your crypto back to fiat.
Typically, you will be taxed on the gains you made, just as if you had purchased stocks and sold them for a profit. In other countries (like the US), selling bitcoin for another cryptocurrency – and indeed every crypto-to-crypto trade you make – is considered a taxable event, thus dramatically complicating the reporting process.
With that in mind, the following is a summary of ways to enter the crypto-ecosystem by buying bitcoin:
Peer-to-Peer and In Person
It’s possible to physically meet a person, hand over cash, and receive the “keys” to purchased bitcoin.
To purchase bitcoin in person you would confirm that the bitcoin has actually been deposited in your personal “wallet” (see “Crypto Wallets” section below) before leaving / handing over the cash. This face-to-face method of purchasing cryptocurrency can (ironically) be considered the most anonymous way to buy.
Bitcoin Teller Machines
In most major cities there is a growing network of bitcoin ATMs (BTMs). Depending on factors such as the location of the BTM, its owner, and the amount of Bitcoin being purchased per day, you may or may not be able to buy bitcoin anonymously at a BTM.
In order to be in compliance with local Anti-Money Laundering regulation, an increasing number of BTM owners in an increasing number of jurisdictions are requiring all purchases to undergo a Know Your Customer ID verification process.
This process generally involves the taking of your picture by the BTM, as well as the requirement to upload one or more forms of government-issued identification. Once you have been approved to purchase, you put your cash into the machine and an equivalent amount of bitcoin is deposited into a bitcoin wallet of your choice.
If you don’t already have a bitcoin wallet, some BTMs can create and print a paper bitcoin wallet for you. Buying bitcoin through a BTM typically incurs a fee of between 5-20% above the market price of bitcoin.
Peer to Peer Online
Another option is to find a seller online and purchase directly from that seller. The most popular site for facilitating this is Localbitcoins, but there are other options like Mycelium Local Trader and Wall of Coins, which provide essentially the same service.
These sites allow you to find people who are willing to accept cash transfers in exchange for bitcoin. In this case, trust is established through reputation, so if you see that the seller has a high rating on the site, you can expect to actually receive the bitcoin once your money has been transferred to their account.
By Centralized Exchange with Cash Transfer
There are now hundreds of centralized cryptocurrency exchanges but only a small fraction of them facilitate the trading of fiat currency for crypto.
Any such exchange – with the exception perhaps of a few that are small enough to operate illegally without getting noticed – will require all buyers to go through their KYC procedure.
This process can take anywhere between minutes and weeks, and for some exchanges may involve extra security measures such as the receipt of a confirmation code to your home address before you are allowed to make a purchase.
Once you are approved with an exchange, you can transfer fiat directly from your bank to the exchange. When the currency has been accepted by the exchange, you can purchase bitcoin (and usually several other top cryptocurrencies) at the rates listed on your exchange.
By Centralized Exchange with Credit Card
A growing list of exchanges now allow small purchases of bitcoin by credit card. This process can be slightly faster and more convenient than the above cash transfer process but still requires some form of verification and generally results in higher fees. If you plan on purchasing a small amount of bitcoin, this is probably the fastest, easiest, and most familiar way for those who are not concerned about anonymity.
By OTC Desk
There has been an increase in the number of boutique trading desks that cater to high network individuals and offer personalized customer service. These have come to be known as OTC trading desks, and they typically have a minimum purchase requirement in the range of $25,000. OTC trading desks can smoothly facilitate your bitcoin purchase at an agreed rate without slippage.
A bitcoin or cryptocurrency wallet is, as the name suggests, a place to store your bitcoin or cryptocurrency.
Before purchasing cryptocurrency, though, it’s essential to understand two key terms related to cryptocurrency wallets:
Public Key / Public Address
This is like your bank account number, except that you will have a different public address for each type of crypto you hold. For Bitcoin, a public address looks something like this:
If you want people to send you bitcoin, this is the address you’ll give them.
This is your secret code – or key – for accessing the funds in your wallet. You need this key in combination with your public key / public address if you want to move your bitcoins or a portion of them to another wallet. A typical private key looks like this:
The Dangers of Storing Coins on Exchanges
The most popular centralized exchanges shield people from the seemingly complex terminology of cryptocurrencies, making the buying process familiar. Not unlike a typical online banking website, you will have an account with a balance, and there will be access to customer support.
For this reason, centralized exchanges are the most common way to purchase cryptocurrencies, and a large percentage of people simply leave their crypto on the exchange.
However, crypto purchased and held on an exchange is not, strictly speaking, owned by you because although you will have a public deposit address for each type of crypto you hold on an exchange, you will not be given the private key to that address.
Exchanges hold the private keys to your crypto, so exchanges are the true custodians of any crypto held on them.
This presents a number of problems because it is only the holder of the private key to a given crypto address who truly has control over that address.
Hacks and Scams
In 2016, Reuters reported that a third of crypto exchanges up to that point had suffered some kind of hack and nearly half had closed, with none offering depositors’ insurance.
While the security standards and reliability of crypto exchanges have greatly improved since the days of Mt. Gox, centralized exchanges continue to be vulnerable to hacking.
The Wall Street Journal reported that at least $800 million in crypto assets had be stolen from exchanges in first half of 2018.
Lack of Support for Airdrops, Forks, and Passive Income
There are some features of cryptocurrencies that enable the holders of the tokens to certain benefits.
Airdrops, for example, are sometimes distributed to all holders of a given coin, with the number of coins given calculated by the number of coins held. In some cases, a coin may fork, or split, into two separate coins, with all holders of the original coin receiving a proportionate amount of the new coin. Some coins also have a staking system, whereby holders of the coin gradually receive additional coins as a form of passive income.
In all of the above cases, if you hold the private keys to your wallet, you will automatically be awarded with the airdropped token, forked tokens, or passive income “interest” tokens accordingly.
However, if you don’t hold the private keys, it’s up to the exchange (who does hold them) as to whether or not they will honor the additional tokens, and – if so – when. There have been numerous cases of centralized exchanges not honoring forked tokens, passive income, and airdrops.
Best Practices for Storing your Crypto
Holding cryptocurrency is a double-edged sword. One the one hand, you become your own Swiss Bank: you gain the ability to secure your assets so strongly that not even a nation-state can force you to give them up. But with great power comes great responsibility.
If you – and you alone – have the ability to access your crypto, you must be extremely careful with how you store your keys: lose your private key, and your crypto is gone forever; let your key fall into the wrong hands and your funds could be transferred to another address, with no recourse and no chance of compensation.
The options for securing your private keys range from writing the key down on a piece of paper to storing sections of it in vaults distributed around the world.
As a general rule, though, the lengths you go to secure your private keys should depend on the size of holdings they access: for small amounts of crypto, convenience is more important. For large amounts, increased security is essential.
Soft Wallets for Smaller Crypto Holdings
A convenient online software wallet, or “soft wallet,” is probably the best option for small amounts of crypto. This article compares some of the most popular wallets for Bitcoin.
Once set up, many of these wallets don’t require you to enter your private key in order to make transactions. On mobile devices, these wallets can be configured to trust that the holder of the device is the one with permission to use the wallet. This makes them work conveniently for sending and receiving money, just like other apps on your phone or in your desktop browser.
Hard Wallets for Larger Crypto Holdings
Anything that is connected to the Internet is open to the possibility of being hacked. Desktop computers and mobile devices that regularly interact with the Internet can be infected with malware that can, for example, track your keystrokes and take screenshots.
A “hard wallet” is a dedicated device that is designed to insulate your crypto holdings (re: your private keys) from the Internet. Popular hard wallets like the Ledger Nano S and the Trezor are a piece of hardware about the size of a thumb-drive that you plug into your computer’s USB port but never directly connect to the Internet.
These wallets are used in combination with a software interface that allows you to send, receive, and track your assets.
Hard wallets are a good option because they make accessing not only your bitcoin, but also many other cryptocurrency wallets you may have, both safe and convenient. They do this by reducing all of your private keys to a single PIN that is easy for a normal person to remember.
The PIN is used to access your accounts on a daily basis, but it is still backed up by a longer and more complex password.
If you lose or break your hard wallet, therefore, you will still be able to access your accounts. You do this by unlocking them with a mnemonic phrase that is generated when you first turn on your hard wallet.
In fact, most crypto wallets have the option of backing up the private key that unlocks them with a mnemonic phrase. This is a random string of words that can unlock your wallet on any other device, meaning access to the mnemonic phrase guarantees access to your crypto holdings for the wallet it backs up.
For the storing of your mnemonic phrase / private key, therefore, you’ll want to follow some best practices:
What Not to Do with your Private Key:
- Don’t save it on your computer.
- Don’t type it on your computer, especially while connected to public WiFi
- Don’t email it to yourself.
Some Options for Storing your Private Key
If you can memorize a long string of random words – and never write it down – this would be one of the safest ways to save your private key. Of course, this is not practical for most people. Even for those confident enough to rely on their memory, there are problems: For example, what to do with your holdings when you’re dead? Also, what if you are tortured until you give up the key?
Writing your Key on Paper
For this reason, most people write their key on a piece of paper. Standard practice would be to use high quality paper, laminate it, and put one copy somewhere safe in your house and another copy in a different safe location like a bank vault. This way you’re protected unless your house burns down and the bank gets robbed at almost the same time.
Dividing your Key
You also have the option of dividing your key into two or more parts, and storing those parts in different locations. This would thwart someone who suspected you had large crypto holdings, and so attempted to break into your house to find your key. At best, they could get half the key.
Some cryptocurrencies (including Bitcoin) support multi-signature wallets. This means that to move assets out of the wallet, two or more private keys are needed. This could be a solution for a shared account between, for example, husband and wife. A multi-signature wallet could also help to mitigate the threat of thieves forcing you to hand over your key.
There is a growing industry of custodial support for crypto holdings. In this case you would pay fees to have professionals manage the storage of your private keys. For large holdings, this may provide the best combination of security and convenience, particularly for less tech-savvy individuals.
Trading Between Cryptocurrencies
Once you have moved fiat cash into the cryptocurrency ecosystem (typically by buying bitcoin) it becomes significantly easier to exchange between currencies. This can be done instantly within centralized trading exchanges like Coinbase and Binance.
For those who have purchased crypto outside of a centralized exchange or are holding their crypto in their own private wallets, it’s easy to trade all or a portion of it by using centralized exchanges. Once you have made an account on the centralized exchange, simply determine the deposit address for the crypto you’d like to trade, and send the amount you’d like to that address.
Simple trading can also be done through decentralized exchanges like Shapeshift, which is built into the user interface of popular wallet applications like Jaxx, allowing you to instantly switch between supported cryptocurrencies within your own wallet.
There are also completely decentralized exchanges that look like traditional trading platforms (with order books and price history).
This article compares decentralized exchanges. Many centralized exchanges are also planning to build or switch to the decentralized model in the coming years. In the decentralized model, tokens are held in smart contracts until orders are matched.
This means at no point does the exchange actually take possession of the private keys to your crypto so, as long as the smart contract doesn’t contain fatal bugs, there is no chance of you losing your crypto due to the exchange suddenly “going bankrupt” or otherwise disappearing with your tokens.
Buying, holding, and trading cryptocurrencies – if done correctly – can give you piece of mind that your assets can never be confiscated and that you’ll have access to them 24/7, 365.
However, best practices must be followed for the safe-keeping of these assets: it is estimated that as much as 23% of the current bitcoin is simply “lost.” This means that people have, for whatever, reason, lost access to their private key.
Before buying crypto, it’s best to decide what kind of investor you are and secure your assets accordingly. If your investment is short term and/or small scale, it’s probably best to go with simple and familiar centralized exchanges.
If you’re scale is large and/or you plan to hold for the long-term, it’s essential to follow the best practices outlined above.