I get asked quite frequently (a few times a day) from friends about which crypto currencies to invest in. The post below provides my current thoughts that I hope will help my friends make better cryptocurrency investment decisions.
From my experience, most crypto investors approach the idea of investing in cryptocurrencies from the bottom up. They hear about a particular crypto currency and then consider whether its a good investment. I think a better approach is to step back and come up with a basic investment strategy, even putting it on paper or in an e-mail is a good idea. Think about your entire investment portfolio and consider how cryptocurrency investments fit with your overall mix. My first and main recommendation is to remember that investing in cryptocurrencies is very risky. Not only is there a risk of hacking and other technological risks, there are also major credit risks, and a almost complete lack of regulation. This means that if your crypto currency investments go sour (or get hacked) you very likely have no legal recourse. So think about the big picture and put things in perspective.
With risks in mind, I think crypto currencies should only make up a small portion of an overall investment portfolio, unless you are in the business of investing in cryptocurrencies, treat cryptocurrency investments as a hobby and a small portion of your overall portfolio.
In addition to a portfolio approach, I also encourage crypto investors to consider active investments, rather than just holding a particular crypto currency as cash. Most crypto investors imagine buying a particular crypto currency with the idea that it will gain in value and they’ll be able to sell it again in the future for a profit (relative to their home fiat currency). While waiting for this time to occur, they simply hold the crypto currency in a wallet or on an exchange. This is a highly speculative activity, and unless you have a particular trading process, I think in the long run the transaction costs and opportunity costs will eat up your speculative gains. But, if you want to take some risk, then buying and holding cryptos on account might still be profitable for you. If you have a clearly defined process to make trading decisions, then you might get ahead. Otherwise, my bots will earn your transaction fees 🙂
I think a better approach is a mix of some cash crypto investments (holding particular cryptos in wallets or on exchange) combined with some active investments where you can earn returns on your capital. This would involve investments where you put your capital at risk and earn returns in exchange, on top of your FX gains. Below I describe three types of crypto investments where you can take risk to earn rewards.
The crypto capital markets are in an early stage of development and so you may find alpha is a lot easier to find than in mainstream fiat economies.
Most of us are familiar with casinos where the financing of the games and the operation of the games are done by the same entity. This is the result of the scale required to run a modern land based casino, but also because of the regulatory structure in most advanced jurisdictions. New technology and the application of blockchains makes it possible to separate the financing of the casino from the operations. We are entering a world in which the bankroll is funded by one group of investors and the operations are done by a separate group. The way this works in practice with cryptos in this “open sourced” model is a casino operator will allow investors to contribute to the bankroll of the games. The operator will then run the games and the investors will receive the gains and losses from the other side of player’s bets. Every period, the operator takes a fee from the gains/losses and attributes the bankroll investors with their portion. The model also works when the operator takes a fixed fee each period.
There are many online crypto casinos operating with this model and new ones are emerging all the time. There are benefits for both the bankroll and the operator perspectives. The bankroll investors get a passive investment that involves only financial risk. The operators get access to capital and so they can focus on running/promoting the games.
The rates of return for bankroll investors can be quite high and depend on the volume of bets the operator can drive through the games. The bankroll risk also depends on the underlying volatility of the games as well as the volume. Offering games with high payoffs or even money payoffs will make an impact on the volatility of bankroll returns, but more bets overall will smooth out those returns. The market will find an optimal rate of return based on these factors.
The bankroll investors must also consider the credit risk of the operator, and this is this is the primary risk at the moment. If the operator is fraudulent, there are very few ways for the crypto currency investor to tell. Some statistical methods of past results can be used to determine the validity of the data, but other than that, a large amount of trust is put in the operator. This might scare away many investors from funding open sourced bankrolls, but the gains are also large and I think in many cases they compensate for the risk. We’re talking about 40% annualized rates of returns on bankroll investments. As long as you stick to the best quality operators.
Here are some open sourced bankrolls to consider:
Each of these casinos are funded by a open sourced bankrolls, and each are all structured a little bit differently. The basic fees that you’ll pay are a percentage of gains attributed to your account each period. A fee of 10% seems to be the current industry standard. These investments can mostly be made with bitcoins, but other crypto currencies as well.
A good way to earn extra income on your cryptos is to lend them out to traders on exchange. This “open sourced” margin lending is offered on a few of the major exchanges including Poloniex & Bitfinex. Their model is to allow traders to take margin loans from users on the exchange for a rate of interest and basic contract terms. There are margin requirements that traders must meet, and if they fall below these margin levels, their position is blown out by the exchange. The nice thing about these loans is since these exchanges are highly liquid, there is almost zero risk of default to the lender (except in the case of a catastrophic event). The main risk to the lender is the credit worthiness of the exchange. If the exchange fails or is hacked, lenders will likely suffer losses. This has happened on both Poloniex and Bitfinex in the past. Although both exchanges eventually refunded the losses.
The way these margin loans work is a user would deposit their crypto currency on the exchange, and then enter into the lending market for particular cryptos. Its an open market, so lenders can choose to work limit orders for particular loan terms and rates. My opinion is that using a bot by accessing the exchange thru their APIs to automatically build your lending book is the best method of investing. It can be time consuming to login each day to make your loans, and you also might find your capital sits idle if you don’t put it out to traders.
Mining cryptos is often times easier than you might think. As long as you’re not competing in the largest and most liquid cryptos. Its tough for a small time investor to earn an economic rate of return mining bitcoins or ethereum nowadays, but there are many new cryptos emerging and there are still lots of opportunities using cloud mining pools and proof of stake coins. There are a lot of cloud mining scams out there, so you need to be aware of the most reputable operators such as Genesis Mining and Minergate.
The toughest part of mining is the technical aspects of setting up the software. Using a mining pool takes away most of this challenge because you can usually just plug into a miner that’s already setup and receive your portion of the group’s reward based on the capacity you contribute.
Another good option to earn mining profits is to setup a proof of stake miner such as CLAMs, NXT, LSIK, and other proof of stake coins. Proof of stake mining rewards are based on the number of coins you have on the miner, and not your computing power. So proof of stake miners are useful for those with capital, but not as much computing power or technical skills.