I am firmly on record as believing that Bitcoin and most of the other cryptocurrencies are poor investments and this is all a bubble which is going to end badly. I’m not a complete nay-sayer, I do believe that blockchain technology is real and will play a role in creating frictionless transfers of money for both people and institutions, but I am nowhere near the point where I can assess which systems are going to be the winners in that race. I most recently talked about the subject in the December update in the section titled Bitcoin.
But $50 billion a week is flowing into the cryptocurrency bubble. As long as that flow continues, the bubble will keep expanding. So over the holidays I sat down to try to figure out if there was a way for me to profit from this ridiculous speculation.
So far it’s going pretty well. I’ve doubled my money since funding my Coinbase account on 12/29. Not that I think that is the result of any skill or special insights, just lucky timing.
I hesitate to write this post, because I know that probably ten thousand people will read this and one or two of them are going to be inspired to start trading cryptocurrencies, get carried away, and make some mistakes they will later really regret. But I have received a huge number of questions on the subject and it is entering the mainstream, so I hope my words of warning and extremely cautious approach will help temper any tendencies to jump in with both feet.
A good time for the usual caveat – I’m not a financial advisor and you should not take anything I write as advice. I write these posts to share my experiences, sort things out in my own head, and start a conversation. This is entertainment and hopefully a little bit educational, but definitely not something you should rely on to make investing decisions.
THE CRYPTOCURRENCY BOOM
At the beginning of 2017, the value of all crypto currencies combined was about $17.7 billion. By the end of the year, more than 1,370 separate cryptocurrencies combined at $605 billion. That’s an increase of better than 3,300% for the sector. Bitcoin started the year at about $1,000 and finished around $15,800. Ethereum went from around $8 to $750 during the same time span. So you can see why I want to dabble.
Investing in crypto last year would have been pretty simple – buy just about anything and hold on to it. I don’t know that it will continue to be that easy (although I’m certainly hoping it will be), so I sat down and worked out what I consider to be a reasonable strategy.
First off, I set a very strict limit on the amount that I would be willing to lose in this experiment. It is the amount of money I would fine with losing at the tables if I went to Vegas for a weekend. Which makes sense – because this really is gambling, not investing. It is less than 0.001% of my net worth. And I don’t plan to ever put another dime into it.
If someone is going to get involved in crypto, the money they put into it should be coming from their entertainment money, not investing money. And it is entertaining, bordering on addictive. It’s a little like having video poker on your phone. And it never stops, Crypto exchanges run 24/7 – there are no market hours.
MY CRYPTO STRATEGY
My strategy at this point is fairly simple – no day trading, no trying to figure out which of the new coins coming onto the market every day are going to explode in value. The money in a speculative bubble flows most smoothly and consistently to investments which are (1) easy to make and (2) to the names being touted as either “the next big thing” or as the market leaders in popular niches.
If you are in the United States and want to invest in cryptocurrencies of any kind, the starting point is Coinbase. This is by far the most popular exchange, has a very easy to use interface, a good iPhone app (which is currently the most downloaded app in the app store), is insured and regulated, and is the only exchange I have found which lets you easily and instantly move money into the market from a US bank account. And if the only coins you want to speculate in are Bitcoin, Ethereum, Bitcoin Cash, and Litecoin, this is the only exchange you need.
100,000 new Coinbase accounts are being created each day. All of that new money coming in goes into these four currencies. So a fairly solid strategy is to buy one or more of those currencies and float up as more people pile into them.
Quick aside: If you register for Coinbase with this referral link, you will get $10 worth of Bitcoin free after buying $100 worth of any of the currencies offered (and I get $10 too). $10 isn’t much, but it will pay for the fee to ACH funds in from your bank to start your account. https://www.coinbase.com/join/5a473a1da4b69a013c2b3292
An even better strategy is to try to figure out which coins not currently traded on Coinbase are going to be added to Coinbase in the future. Lowering the barrier-to-entry for the masses increases demand dramatically. Looking back at the performance of Bitcoin Cash, Litecoin and Ethereum immediately upon being added to Coinbase shows just how significant that listing is. Coinbase (under it’s GDAX brand) put out a white paper on the factors it will consider when choosing additional cryptos to list – factors which I am using to help make decisions on what to buy.
To buy other cryptos before they are selected for listing on Coinbase, of course, you have to go to other less accessible exchanges. And if you want to speculate in most other coins out there, Binance is probably the exchange you want to register on. At the time of this writing, they list 108 different coins (including all of the ones on Coinbase). Binance is Hong Kong based, so the only way to get actual US money into Binance is through an expensive wire transfer. But there is no need to do that when you can buy Ethereum on Coinbase and then transfer that instantly to Binance.
Another quick aside: If you register for Binance with this referral link, you won’t get anything at all, but the TSP Allocation Guide will receive a fraction of the fees you pay when you trade cryptos, so please use the link: https://www.binance.com/?ref=20583308
Kucoin (mentioned by Matthew in the comments below) is another, newer cryptocurrency exchange based out of Hong Kong. I have been reading about it because it is often the first exchange to list hot new coins (it had NEO before Binance did), but I haven’t traded on it yet so while I can vouch for it being very easy to register for, I can’t write much about ease of use or performance at this point.
The last aside, I promise: Kucoin has an interesting three-level referral program, so if Matthew refers me, and I refer you, and you refer Bob – when Bob makes a trade you get 20% of the commission, I get 12% of the commission, and Matthew gets 8% of the commission. So you should definitely join using this link: https://www.kucoin.com/#/?r=2cPK7 and then tell all of your friends to join as well so you, Matthew and I all get rich $0.02 at a time.
COINS CURRENTLY HELD
Ethereum (ETH): I have more ETH than all other coins combined. It is the #2 cryptocurrency in the world by market cap after Bitcoin. It fixes all the terrible problems which vex Bitcoin and I think it is the Facebook to Bitcoin’s MySpace. It has tremendous support from the community, academia, and the business world (the Ethereum Enterprise Alliance). It is fast to transfer and is supported on every exchange, so this is my default coin.
Bitcoin (BTC): I have a little bit of Bitcoin, even though that’s not really cool anymore. There was a huge rotation out of Bitcoin into Ethereum and a dozen other contenders late last year. I think that rotation may have been over done and that the pendulum will swing back. I also believe that because most “normal” people have only ever heard of Bitcoin in the cryptocurrency world and it is the #1 coin out there, a lot of new money will continue to flow in BTC.
Don’t get me wrong, I don’t like Bitcoin for the long run. Bitcoin transactions are so slow and expensive that it has become virtually unusable. So the cheerleaders have started to call it a “stored value asset”, meaning that it is a place where you can park your money safely. It is not that – it is volatile (it once lost 30% of its value in a single day), it generates zero income, and it is not particularly secure.
But I still own a little, and it is up about 10% since I bought so I must be right.
Stellar Lumens (XLM): a very fast payments protocol, the civilian version of Ripple (XRP) described below. XLM is used as the currency in the Stellar payment network. It is a distributed, hybrid blockchain designed to facilitate payments.
Neo (NEO): a Chinese version of Ethereum, it is the first decentralized, open-source cryptocurrency and blockchain platform launched in China and enables the development of digital assets and smart contracts.
Eos (EOS): similar to Neo and Ethereum, but heralded as faster and easier to work with. Newer, so not as much support to this point. Headed by Dan Larimer, the founder of two previous successful coins (STEEM and Bitshares). Eos is designed to support commercial-scale decentralized applications by enabling businesses to build blockchain applications in a way similar to web-based applications.
Monero (XMR): one of the leaders in the privacy/anonymity area. Bitcoin is actually pretty easy track, Monero aims to prevent that by obscuring key data from the public ledger. Because one of Coinbase’s factors in selecting future coins to list is their ability to comply with anti-money laundering requirements, XMR is the least likely of this group to be listed. But it has a strong community and will continue to attract users who value privacy above all.
Coins I don’t own, but am watching closely:
Ripple (XRP): the #3 crypto in the world by market cap. Super fast,a real-time gross settlement system, currency exchange and remittance network. Different because it is being developed as part of a system for financial institutions to move money quickly and easily around the world. It ran out of its shoes at the end of last year and is currently about 30% below its highs. This is one that I will get into once I think the price has leveled out.
Dash (DASH): similar to Monero, DASH is a cryptocurrency with a focus on privacy and speed. It was rebranded from Darkcoin as an attempt to stop being associated with the “dark web.”
Iota (MIOTA): focused on becoming the backbone for secure machine-to-machine payments in the Internet of Things economy. Created without the use of a blockchain, instead it is based on a distributed ledger architecture called “The Tangle,” which allows it to achieve zero-cost transactions, offline transactions, and infinite scalability. Recently partnered with Microsoft, which gave it a huge boost.
Now that I’ve sort of figured out the basics, a few other areas I plan to look at more closely:
- identifying new coin offerings which are likely to generate momentum based on the team behind them and their use case. Entertaining to try to find the next big thing when it is still selling for pennies and ride it up 1000x, but obviously difficult to identify the good ones in all the noise, particularly as there is an entire industry pumping new coins for profit.
- Cloud mining. This is where you “rent” computing power in the cloud and participate in the creation of cryptocurrency in that way. It is simple in theory – you know what the value of a particular coin is right now and you know how much of that coin you can generate with that rented computing power. The problem is that you don’t know what the value of the coin will be in a year, or how much how much you can generate as the algorithms change over time. The people I know who have done this have come out way ahead – so far. Hashflare, an Estonia based company, is the biggest and best known of the cloud miners.
- I still have an unhealthy fascination with mining cryptocurrencies (which is where you construct a purpose-built computer with powerful graphics cards and are rewarded with cryptocurrency for running software which solves algorithms as part of the verification of block-chain transactions). Free crypto, but does entail initial outlay for hardware, significant cost of electricity, and the knowledge that you are doing bad things to the environment. If any of you have relatively modern GPUs sitting around in a box, let me know.
- figuring out if there is a way to take advantage of the discrepancies between pricing on different exchanges. (This one would probably only work effectively if either I or a partner had a foreign bank account to which withdrawals could be made in local currency from high-flying foreign exchanges such as those in Korea). Listed last because I see this as the most difficult to figure out and implement.
STORING YOUR PRIVATE KEYS
Right now I have such a small amount invested that my coins are still “stored” on various exchanges. That, of course, is not smart as exchanges are targets and susceptible to being hacked. (Coinbase is insured for the value of all the coins on the exchange and that’s where I keep my ETH and BTC, so I’m fairly comfortable with that for now). One of my tasks this weekend is to figure out the software wallets I need to store my coins more securely and I will update this post when I have finished doing that. Eventually I will want a hardware wallet as well, but I may need to wait a generation for one which will allow me to store all of my coins on one device. If you have suggestions, please share in the comments below or in the message board thread.
Taxes for people trading cryptocurrencies are going to be somewhat complicated, unfortunately. My understanding is you will have to report capital gains (or losses) on any exchange between coins that you make, not just when you eventually cash out. So if you deposit $100 to Coinbase and buy ETH, then transfer that ETH to Kucoin and trade your ETH for NEO, your gain or loss on the ETH during the time that you held it is reportable. And then when you trade your NEO for something else, that gain or loss will also be reportable. And so on, and so on, and so on. But don’t let that intimidate you, this is the same system used for taxing gains on individual stocks, mutual funds or any other asset you sell. It is slightly more complicated though, because the exchanges don’t issue 1099-B forms the way brokerages do for capital gains on stocks, so you will have to keep records for yourself.
If you hold a coin for less than a year, you will pay short-term capital gains at the same tax rate as your ordinary income. If you hold a coin for more than a year, gains are subject to your capital gains rate, which varies depending on your tax rate as follows: taxpayers in the 10% and 15% tax brackets pay no tax on long-term gains on most assets; taxpayers in the 25-, 28-, 33-, or 35- % income tax brackets pay a 15% rate, and taxpayers in the 39.6% bracket pay a 20% rate.
This post is way outside the goals of this website (and probably directly counter to my mission of encouraging sensible, economy based investment decisions), so I don’t plan to send out new posts on the subject. Instead, I will occasionally update this post and participate in discussions on the message board thread I have created here. I have about a month and a half into really looking at the crypto world, so I hope that the many TSPAG readers who are much more experienced than I am will share their lessons learned and strategies in that thread.