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How to Recognize the Best Investment Opportunities in Cryptocurrencies

Recognizing the best opportunities among cryptocurrencies is a mix of technical knowledge and caution. Cryptocurrencies, led by bitcoin, became one of the hottest assets in the past decade. Their obscure beginnings on cryptography forums, and their early adoption by gamers and nerds did little to predict the appeal of BTC and a myriad other assets, forming their own hot, risky market.

Over the years, a handful of models for significant returns emerged:

• Long-term holding of digital coins, leading to unexpected price appreciation;
• Short-term trading;
• Token sales for new projects, with the potential for significant price appreciation of the token;
• Lending and collateralized lending offering APR higher in comparison to bank accounts;
• Staking, or holding onto crypto coins in exchange for passive income.

For years, BTC and its copycats and contenders looked nothing like an investment opportunity, except for a few lucky or prescient early adopters. The rise of BTC to nearly $20,000 and its ability to command a price of thousands of USD could not be predicted from its humble beginnings, trading at $1 a decade ago. While past performance does not guarantee future price growth, the rise of BTC happened during a decade of generalized market boom across all asset classes.

The rise of crypto assets happened during an unprecedented period of low interest rates, quantitative easing, and a decade of growing wealth and appetite for risk. But for BTC and all other coins and tokens, it was not all smooth sailing. In fact, BTC started to show a pattern of quick gains, followed by protracted bear markets. So while crypto coins could achieve outlandish gains, the risk was real. BTC was capable of wiping out 86% of its value within a few short weeks.

Cryptocurrency investment thus holds opportunities for fast gains, interspersed with severe market crashes. It is best to approach the crypto space with awareness of this potential for fast losses.

Finding investment opportunities while avoiding pitfalls should focus on:

• Technological soundness and avoiding hacking risks by gaining awareness of blockchain technology.
• Looking for liquidity, community and indicators of public interest, including exchange volumes, social media engagement and if a coin is fairly distributed or monopolized by the developers or early bulk buyers;
• Transparency and potential legal and taxation problems stemming from the investment;
• Common sense check on outlandish claims, overpromising returns and signs of a Ponzi scheme.

Crypto Price Action: Asset Bubble or Real Opportunity?

Because of the relatively volatile price action, the crypto space was often called an asset bubble. However, after multiple boom and bust cycles, crypto trading proved remarkably resilient.

The infrastructure around crypto coins gradually improved. Despite glitches and hacks, exchanging and trading crypto assets continued to evolve, attempting to mimic traditional markets. While still unregulated, exchanges started to impose internal rules to avoid some of the worst market exploits.

On the surface, crypto prices showed signs of being a bubble. In late 2017, mainstream attention to BTC helped bring about an absolute price peak. During that time, new buyers borrowed and sank cash into an overheated market. With easy cash still available, irrational exuberance took hold and BTC indeed went through a bubble phase.

But after correcting deeply, BTC and other assets showed resilience. Interest in trading continued to evolve in new forms. Crypto assets started to show they are here to stay, presenting an opportunity for an alternative type of investment.

How Bitcoin Grew so Powerful

The beginnings of Bitcoin were humble, with only a handful of computers making up its nascent network in the early days of 2009. Since then, the first and still leading digital coin acquired its reputation as “digital gold”, and became influential in many aspects. Soon, digital coins also gained value as a tool for international remittances, where other types of payment systems faced limitations.

One of those aspects is mining, or the creation of new coins and the process of recording and securing new transactions. The Bitcoin network is so large, the machines that make it up consume more electricity than Austria. Since 2013, mining new BTC became increasingly competitive, leading to the creation of vast data and computation centers, known as “mining farms”. No other digital coin has the same computational power, thus making BTC the most tamper-proof coin in the world.

In the case of BTC, anyone trying to compete and produce more coins will need to make a large upfront investment in machines and a source of electrical energy.

The high mining cost of BTC is one of the reasons the coin has value - its scarcity. Only 900 BTC are produced each day, a valuable resource offering large-scale, borderless transactions. However, scarcity alone does not explain all of the greed for BTC. Yet the strong brand, the track record, and increasing curiosity increased the influence of BTC.

Trading Crypto: Fair Value, Risk, and Dangerous Pumps

For all of the hype and brand influence, there is no formula or set guidelines to estimate the fair value of crypto assets. Markets are still unregulated and there are no trading stops or rules for order books.

A coin could move up from fractions of a cent to a few dollars, on nothing but greed and hype. In the summer of 2020, the phenomenon of daily booming decentralized projects showed that valuations in the hundreds of millions could come by within days. The volatility of those assets is extreme. So-called DeFi coins took over the market, creating wild price fluctuations, as in the case of the SushiSwap token.

For BTC and more established coins, price fluctuations are not as dramatic. Years of trading have established more reasonable boundaries and price expectations. Older coins go through bull markets, but rarely offer an increase of 1,000%.

Models exist to suggest BTC may trend in a certain direction, such as the stock-to-flow model. Stock-to-flow derives from the idea that BTC behaves as a scarce commodity, hence its decreasing block reward over the years will correlate with price increases.

Others base the fair value of BTC on its high cost of production, which ranges between roughly $3,000 and $10,000 per coin.

Still, crypto markets have often behaved in ways suggestive of coordinated pump operations. Evidence of such activity includes bot-generated orders, as well as tracking transactions that suggest large-scale owners, or “whales”, try to sway the market.

Trading activity, whether coordinated or not, is in the end the final determinant of an asset’s price. Having a consistently liquid market means some of the leading assets, such as ether, bitcoin cash, or XRP, can preserve relatively stable values. For other coins and tokens, the process of price discovery is often much more turbulent.

Bitcoin Futures and Price Fluctuations

For years, BTC traded on a spot market. But as markets matured, exchanges started offering futures products, betting on BTC price moves with leverage. This increased interest in BTC trading, allowing anyone to take a position and possibly make significant gains.

Futures, however, remained extremely risky. Based on BTC spot prices, futures often led to liquidations when the asset changed direction rapidly. BTC has been known to liquidate short positions by climbing by $1,000 and more within an hour. Reversely, long positions have been liquidated by a rapid price crash. This cycle of liquidations has continued for years, and most traders remain aware of the risk.

Futures trading with leverage remains one of the most liquid markets, with BitMex announcing volumes in the billions of dollars. However, the potential for rapid liquidations and no regulations to trading crypto futures makes this opportunity highly risky.

What are Stablecoins and How They Affect Cryptocurrency Prices

Digital assets rarely trade against real-world currencies, as in the early days of unregulated exchanges. For that reason, a substitute to cash settlements appeared in the form of tokens worth exactly $1.

The first stablecoin, Tether (USDT) appeared in the summer of 2017, and quickly expanded its influence. The increased supply of USDT also coincided with the rise in BTC market prices. The supply of USDT grew from a few million tokens to above 13 billion, becoming the chief source of liquidity for most leading assets. USDT forms pairs on most well-known cryptocurrency exchanges. A full list of dollar-pegged coins can be found with comparisons in influence and coin supply.

Stablecoins reportedly reflect real demand for crypto assets. The need for stablecoins arose after regulators in China, but also in the US and the EU, started to tighten the rules for trading BTC directly against fiat. Unlike fiat, a stablecoin such as USDT can move to any address across the globe, almost without delay. This borderless value transfer opportunity also helped create arbitrage opportunities.

Token Economics and Crypto Investments

Tokens are the most agile digital asset. Unlike bitcoin, tokens do not require a special investment, and can be created almost immediately through code. Tokens exist on top of crypto coin platforms, but Ether is the most prevalent technology to carry those assets.

The advantage of tokens is that they can represent value in multiple economic models. From in-game purchases to digital collectibles, tokens are the most abundant source of investment opportunities. Unfortunately, they are also the riskiest possible path to returns.

Tokenomics, or token economics, relies on new investors that believe in the value of those assets. As discussed before, the value of crypto assets comes from scarcity, trading, and from general hype. In the past three years, tokens have shown price growth of as much as 1,000% per day. But during a bear market, roughly 99% of tokens lose more than 99% of their value.

Types of Tokens

Tokens have a few varieties. They can be differentiated by the platform they run on - Ether, Waves, NEM, and many others.

There are also fungible and non-fungible tokens. The fungible ones can serve as means of payment, or a representative of value. Non-fungible tokens are specially coded to represent a digital item, usually an image. Owning the token also means owning the rights to the image. The non-fungible token technology stands behind crypto collectibles such as CryptoKitties or other types of cards. Just like other tokens, collectible items can go up in value exponentially, then crash as soon as interest wanes.

Utility Tokens

Most token-based projects will strive to explain the need to issue their own digital asset. Usually, some form of utility such as paying for network fees or storage will serve to explain away the token. According to project founders, the token will go up in value as there is more demand for the service.

While some tokens do indeed rise in value, utility tokens do not guarantee returns.

Security Tokens

Security tokens appeared in 2019, as an answer to increasing regulatory scrutiny of utility tokens. After multiple launches of new assets, which closely resembled IPOs, the US Securities and Exchange Commission started to explore the nature of those assets. Multiple projects were fined, because their tokens resembled securities, or promised passive income, a form of dividend, or other types of returns.

While owning a token does not promise a share of the business, the actions of the US SEC caused startups to move to a new standard, security tokens. Those tokens aim to fulfil the requirements for issuing securities.

As of 2020, there are very few security tokens, and only a handful of exchanges try to list those assets. Security tokens nevertheless remain promising for extending crypto investments into the mainstream.

How to Start Trading and Investing in Cryptocurrencies

The best approach to investing in crypto assets is to gain solid knowledge of wallet technology. Being able to store bitcoin safely and securely opens the doors to multiple investments. Wallets are accessible as mobile or desktop software, or as special hardware devices offering even better security.

The next step is to establish an account with one of the available exchanges in your jurisdiction. For the US, Coinbase is the go-to crypto exchange. Kraken is yet another option. For Europe, options include Binance, CEX, Bitpanda, Kraken, and other international exchanges. Korean exchanges like Upbit and Bithumb remain highly active in Asia, and OKEx is highly prominent on the Chinese market. Limitations may apply and most exchanges will require some form of identity verification.

The best approach to buying or trading crypto assets is to avoid investing a sum you cannot afford to lose. All crypto assets are highly volatile in comparison to traditional investments. However, some types of investment schemes and tokens are much riskier than others, relying on short-term hype and pump-and-dump events. The best approach is to look at a coin’s price history and decide if the risk is worth it.

Some of the older digital assets remain more liquid, though their price action is slower. Newly created tokens may look hot, but they can also crash within days. The best approach is to diversify and avoid over-investing in the hottest new assets.

Be aware that new tokens pose challenges in using wallets, and are more prone to hacking and loss. BTC so far remains one of the most secure coins, with well established wallets.

Tools for Cryptocurrency Investments

Here is how to start learning about pricing and trading, and possibly discovering investment opportunities in crypto. Tools to trade or buy and hold are available through multiple platforms. Some of the most well-used resources include:

• Coinmarketcap.com - generalized information on price, volume, availability for most coins and tokens;
• Messari.io - detailed cryptocurrency information and specialized metrics;
• Weiss Ratings - an attempt to rate crypto assets based on technological and market factors;
• CoinGecko - detailed data on coins and tokens;

Bitcoin and Mainstream Investment Tools

While the most straightforward investment is to buy cryptocurrency outright through an exchange, there are also approaches that use mainstream investment tools. In the case of bitcoin, ongoing attempts to build an exchange-traded fund (ETF) for the US market were mostly met with denial from regulators.

But for European investors, it is possible to buy bitcoin through the Exchange-Traded Product Bitcoin and Ethereum trackers. Traded on NASDAQ Nordic exchange, those tools expose users to BTC price risk, without owning the actual coins.

For US investors, one approach is to use the Grayscale funds, which sell shares correlated to the market price of BTC and a handful of leading digital coins.

The third group of mainstream products are futures contracts derived from the price of BTC. The leading futures opportunities come from the Chicago Mercantile Exchange, and the Bakkt exchange. So far, adoption remains relatively weak in comparison to direct interest in purchasing through exchanges like Coinbase.