4 things to know before investing in Bitcoin
As with all investments, it pays to know what you're buying. The potential upside may be highly appealing but the risks shouldn't be ignored.
Here are a few things to keep in mind while considering a Bitcoin investment.
1. Bitcoin is still a volatile, high-risk investment
Bitcoin's value may have skyrocketed overall but it's certainly been a shaky takeoff.
To illustrate, here's the performance of the Vanguard S&P 500 ETF (VOO) — widely considered to be a pretty stable investment — for the past five years:
… versus the performance of bitcoin over the same time period:
Yes, Bitcoin (BTC) has vastly and objectively outperformed VOO, but the peaks and valleys are more extreme — if you bought some Bitcoin in late 2017, for example, and were forced to sell during the pandemic, you'd have lost up to 60% of your investment.
Is that to say Bitcoin is a bad investment? Not necessarily — just a volatile one that belongs only in the riskiest corners of your portfolio.
2. Buying Bitcoin isn't the only way to invest in Bitcoin
What if you support the idea of Bitcoin but don't want to expose your portfolio to that much risk? Or more simply you don't want to jump through the hoops of buying and storing cryptocurrency?
You're in luck; the SEC has finally started approving the first Bitcoin ETFs. You can read all about them — risks, strategies and all — in our guide “Crypto ETFs: How to Invest in a Bitcoin ETF.”
You can also invest in the technology behind Bitcoin, also known as “blockchain.” Bitcoin was never intended to be an investment. Rather, the focus was more on getting blockchain to work.
Further reading: How to invest in cryptocurrency without buying coins
3. Bitcoin isn't the only crypto to consider
If you're looking to invest in cryptocurrency in general, it's worth remembering that Bitcoin isn't the only option in town.
For example, take the second most popular crypto by market cap: Ethereum.
Ethereum (ETH), launched in 2015, gained massive popularity based on its technical innovations over Bitcoin, including but not limited to:
- Allowing for the recording of more forms of data to the blockchain, as opposed to just transaction data.
- Using a proof-of-stake model vs. Bitcoin's proof-of-work model, the former being significantly more eco-friendly.
You, like many other crypto investors, may see promise in the versatility of Ethereum over Bitcoin. Plus, investing in multiple cryptos lends a little diversity to your high-risk crypto portfolio.
4. Bitcoin profits are still subject to capital gains taxes
In 2014 the IRS declared all crypto capital gains to be taxable back. In 2016 it issued 14,000 warning letters to crypto tax dodgers. To find these people, it used investor data it wrestled away from Coinbase in court. In 2020, it issued 10,000 more letters.
The 2021 Infrastructure Bill cracked down on crypto tax reporting even further. As a result of the bill's passing, all cryptocurrency exchanges will soon be required to file Form 1099-Bs on their users. This mandatory annual tax reporting for crypto brokers starts in 2023.
So even though you haven't officially become a bitcoin investor yet, I stress this point on the front end because I don't want the IRS to send Ringwraiths after you. If you do buy bitcoin after reading this article, consider bookmarking our “tax guide to cryptocurrency investments.”
How to invest in Bitcoin
With all that preamble over, let's dive into the steps involved in a smart Bitcoin investment.
Step 1: Choose a crypto exchange or platform
Your first step of course will be to choose where to buy your crypto.
Like USD, Bitcoin is the same no matter where you “withdraw” it from. Therefore, your primary considerations will be safety, convenience and fees.
We've published a whole story on the best crypto exchanges, but to help narrow your search, here are my top three picks for beginners.
For most beginners: Coinbase
- Pros: Extremely user-friendly; a publicly traded company; earn free crypto with Coinbase Learn.
- Cons: High trading fees; can't control wallet keys.
Coinbase is a household name for crypto buying for a reason. It's not only the first crypto exchange to go public; it's also the softest landing pad for crypto beginners.
Coinbase knows that crypto investing can be a little intimidating, so it designed its buying process to be as streamlined as possible. You pretty much just sign up, attach a payment method and — boom — buy crypto like it's Amazon.
Plus you can earn free crypto by watching short training videos on Coinbase Learn.
Coinbase's Learn and Earn
The chief drawback to Coinbase is that it charges higher-than-average fees: up to $2.99 per transaction plus a spread fee of around 0.50% between purchase and sale prices.
But due to convenience, safety and customer service, many traders stick with Coinbase for the long haul. Find out why in our Coinbase Review.
For aspiring advanced traders: Binance.US
- Pros: Low trading fees; both simple and advanced dashboard options; lots of altcoins.
- Cons: Not quite as beginner friendly as Coinbase; under more scrutiny.
Binance.US is the “lite” version of Binance, which is the world's largest cryptocurrency exchange by volume. Binance.US exists to navigate the red tape of U.S. regulations. And while it may not have all of the features and altcoins (non-bitcoin cryptos) of its international parent, it's a compelling rival to Coinbase in its own right.
The platform's chief advantage is its low fees: just 0.5% for instant buying and selling. You can lower your fees even more if you use Binance's proprietary crypto, BNB, to cover the fees.
Binance.US is also an excellent exchange for beginners to grow into. It offers both simple and advanced dashboard options as well as a greater selection of altcoins than does Coinbase.
The downside to using Binance.US is that the platform is currently attracting regulatory scrutiny. That's not uncommon for crypto exchanges but it's something to keep an eye on nonetheless.
So if low fees and wide selection are appealing to you, Binance.US is a compelling choice.
Continued reading: How to trade cryptocurrency (and whether you should)
For the best of both worlds: eToro
- Pros: Supports numerous asset classes, beginner and advanced crypto trading tools are available.
- Cons: Pay a 1% crypto trading fee.
If you want to invest in cryptocurrencies but also stocks and ETFs, eToro is one of your best options. This broker supports 60+ popular cryptocurrencies as well as over 2,000 stocks and over 250 ETFs.
There's a 1% trading fee whenever you buy and sell crypto with eToro. You can use simple spot trading or eToro's advanced crypto exchange if you want more trading tools. There's also virtual trading with up to $100,000 so you can practice your trades without putting money on the line.
Read our eToro review for all the details or try out eToro today.
For a crypto rewards credit card: BlockFi
- Pros: Offers a crypto credit card, regulated in the U.S.
- Cons: Limited selection of cryptocurrencies.
BlockFi is a cryptocurrency platform that’s licensed and regulated in the U.S. Not only can you purchase crypto through BlockFi, but you can also get crypto-backed loans.
The platform also offers a two-factor authentication wallet with no rehypothecation of the crypto assets, meaning it's not used as collateral for other loans.
And you can also get a crypto rewards credit card through BlockFi. The BlockFi Rewards Visa® Signature Credit Card earns 1.5% back in crypto on every purchase that's made with the card and 2% after you've reached $50,000 in annual spending. Find out more in our BlockFi Rewards Credit Card Review.
Step 2: Connect your bank account to the exchange
Step 2 is pretty straightforward — at some point, your chosen crypto exchange is going to ask you to connect a bank account as your primary payment method. Hand ’em your bank account and routing numbers and you're good to go.
As simple as it is, Step 2 does raise a common question:
Can I buy crypto with a credit card?
In most cases, no. In fact, Coinbase, like most crypto exchanges, won't even let you add a credit card.
Here's why: Most banks treat crypto purchases like cash advances. Therefore, your bank will immediately charge you a cash-advance fee of 3% to 5% of the purchase amount. It also won't give you a grace period, meaning you'll accumulate high interest on your crypto purchase immediately. Heck, if the exchange isn't U.S. based, it'll even charge you a foreign transaction fee on top of everything else, just for good measure.
But banks don't mind wiring the money from your bank account to the exchange. The reason is simple: That's your money, not theirs.
So if you were hoping that your bitcoin investment would earn you some rewards points on the side, sorry to burst your bubble.
Step 3: Place an order
Now that you've registered for an account and attached your bank account, it's finally time to buy some bitcoin!
On most exchanges, you're never more than a click or two away from buying bitcoin. Click the big Buy/Sell button and you'll be brought to a page like this one from Coinbase:
Next question: How much should you buy?
Well, this article is more of a how to than a how much. But since we're here, I will say this to help you come up with an initial purchase amount:
- Re-familiarize yourself with the “Before Investing” section above.
- Determine your risk tolerance.
- Speak to your wealth advisor (or consider getting one) to determine how much of your portfolio you should dedicate to very-high-risk investments.
- Start small — Put in a small fraction of a paycheck and watch how it performs over time.
- Finally, don't worry about purchasing round numbers (like 1 BTC for $50,000) since exchanges support partial coins.
If you're getting cold feet, remember that you can always earn free crypto, risk free, through Coinbase Learn or from bitcoin mining.
What's Bitcoin mining again?
Mining is how new bitcoins are put into circulation. When you offer some of your computer's processing power to building and maintaining the blockchain, you're automatically rewarded with a tiny trickle of bitcoin — hence, “mining.”
Unlike the “old days” of bitcoin mining, you don't need a computer science degree to set up your operation. Nowadays, you can just add your computer's processing power to a shared pool through a service like NiceHash and share in the rewards.
Step 4: Store your Bitcoin
At Step 4 we reach a hotly contested debate within the crypto community:
Do you store your crypto in a “hot wallet” with the exchange where you bought it? Or extract it to an offline “cold wallet”?
First, let's discuss what wallets even are.
What is a cryptocurrency wallet?
A crypto wallet isn't what it sounds like — it's not where you store your crypto, since crypto lives on the blockchain.
Rather, a crypto wallet is where you store the keys to your crypto.
When you purchase crypto, you're given two long strings of code: a public key and a private key.
- Your public key is like your account and routing numbers combined — it's what lets others send you crypto — but that's all they can do with it.
- Your private key is like your account password — anyone who has your private key can decide what to do with the crypto inside your account.
Now, your exchange will always have your public keys ready to copy and paste. The question and ongoing debate within the community is where best to store your private keys: a hot wallet or a cold wallet.
- A hot wallet, aka virtual wallet, is when you store your private keys in a database online. Most exchanges will automatically generate a hot wallet for you and encourage you to keep your crypto there, citing their rigorous security measures.
- A cold wallet is when you store your private keys offline on a USB stick, hard drive or even a piece of paper.
Most beginners start with a hot wallet out of convenience — it's free, it's automatically generated for you and you don't have to remember where you put it. Hot wallets also enable instant trades — you don't have to manually input your private keys or plug in a USB each time you make a trade.
Looking for a crypto wallet? These are our favorites right now.
But be aware!
Many traders still prefer cold wallets due to safety concerns. To date, several billions of dollars of crypto has been stolen by hackers stealing private keys. And because crypto holdings aren't FDIC-insured, the victims have been mostly out of luck. The major exchanges have beefed up security and purchased private insurance, but many experienced traders still aren't convinced.
Should you use a hot wallet or a cold wallet?
If you plan to invest only small amounts in bitcoin and continue making regular trades, you'll likely be happier with a hot wallet — it's convenient, flexible and free.
But if you plan to purchase large amounts of crypto and hold it for the long haul, you might consider the safety of “hiding it under the mattress” in a cold wallet.
Just don't lock yourself out of your Bitcoin fortune by forgetting where you put it!
And for more on wallets, check out “Hot wallet vs. cold wallet.”
Step 5: Manage your Bitcoin investment
Your final step to becoming a bona fide bitcoin trader is to know when to buy, sell or hold — or as crypto stans say, HODL (see below).
For lack of a better idea, there's nothing wrong with a buy-and-hold strategy. Timing the stock market is tricky, and by comparison, bitcoin's behavior is less predictable than a pig on LSD. So “timing” a bitcoin trade just right can be extremely difficult — even a lesson in futility. You may simply want to hold until you need to sell for a large cash purchase, like a home down payment or emergency bill.
I'll leave you with this: the original forum post from 2013 where the legendary term “HODL” (hold on for dear life) originated. The drunken diatribe perfectly encapsulates why so many crypto traders have adopted a buy-and-hold strategy — they truly believe in the promise, potential and skyward performance of bitcoin.
The process of buying Bitcoin has never been more technically straightforward, but you'll still have key decisions to make along the way. Do I invest in bitcoin itself or blockchain? Which exchange do I pick? Where should I store my keys? Et cetera.
But hopefully this guide has helped you answer these questions and help you understand how to invest in bitcoin so that you can invest not just efficiently, but safely and smartly as well.
BlockFi Bankruptcy Notice -On November 10, 2022, BlockFi announced that it had to suspend withdrawals from its platform due to the FTX liquidity crisis. As a result, consumers should not be using the BlockFi platform. As of November 28, 2022, BlockFi officially declared bankruptcy.