Originally crypto exchanges were known as a good place for bad actors to transfer funds anonymously. But the market has evolved since 2010 when Bitcoin, the most prominent digital currency, was first introduced. In its recently released 2021 State of U.S. Crypto Report, exchange provider Gemini found that just over 21 million adults or about 14% of the U.S. population now owns some form of cryptocurrency, and those numbers are expected to double this year. Several factors are fueling the interest. Unprecedented levels of fiscal stimulus mean that more people have excess money to spend. The meteoric rise in digital currency prices combined with a good deal of social media “buzz” has also helped draw in investors suffering from a “fear of missing out” mentality. Finally, buying and selling cryptos is becoming easier and the range of products more diverse. Make no mistake, buying cryptocurrencies at today’s elevated levels (see chart below) is speculation at best. But for those who want to jump on the bandwagon or are just curious, here is a quick and simplified primer on how to get in on the game. While there are over 4,000 cryptocurrencies in existence today, I will use Bitcoin in my example.
Your first step is to establish a personal “wallet” to store your Bitcoin. You have two options here. The safest way is to set up a “cold” or off-line wallet by downloading software from a provider like Coinbase directly to your computer or USB drive. A less secure but more convenient approach is to create a “hot” wallet by setting up an account on an internet-connected phone, tablet, or computer. Most online trading platforms also allow users to set up wallets to store their digital currencies. In both cases, wallet owners are provided a set of private “keys” that are used to access their Bitcoins. Lose the keys and you lose access to your funds.
Once you have a “home” for your Bitcoin, you need to choose an exchange that will sell you cryptocurrency. An email address and password are generally required to set up an account. While the process varies by site, a range of security checks typically follows, which can include providing a phone number (typically for dual factor authentication) or a scan of a photo, your passport or driver’s license. These steps are used to ensure the site meets anti-money laundering or other security law requirements. You will also need to select a way to pay for your Bitcoin. Accepted forms of payment include debit or credit cards and bank accounts. Bank accounts (which allow faster money transfer) are generally preferred although not all institutions allow deposits to crypto exchanges. Fees vary too. Credit and debit card fees can run in the 3%-5% range while transaction fees for bank accounts are typically lower, in the 1%-2% range.
So, once you have your wallet, transferred funds into the wallet and purchased Bitcoin, now what do you do? Investors’ motivations for buying cryptos vary widely. Clearly entertainment is a factor for many as the pleasure of watching their account go up (and down) is hard to resist. A small but growing group of buyers are using cryptos for transaction purposes. Tesla was probably the highest profile and earliest company to accept Bitcoin as payment but has recently suspended its use on environmental concerns. Other companies accepting Bitcoin today include Reed Jewelers, Expedia, Subway, Dish Network, Overstock and Mint. Finally, many investors wary of government regulated currencies are buying cryptocurrencies as a hedge against inflation. Their belief is centered on the idea that cryptos will hold and potentially increase in value because many have a limited and finite supply.
While I do not believe that cryptocurrencies like Bitcoin will ever pose a threat to more traditional “fiat” currencies, I do think they will increasingly be used as an alternative payment method and asset class. But for now, I think most investors should take a pass. Cryptocurrency markets remain largely unregulated, volatility is extreme, and the process of transacting still cumbersome. This could change soon, as at least two Bitcoin ETFs are under review by the SEC.