How to invest in bitcoin: The major ways to buy, their pros and cons, and the strategies to consider

  • From financial apps to publicly traded funds to crypto-exchanges, there are now a multitude of options for investing in bitcoin.
  • Bitcoin remains risky and volatile, so individuals should invest small amounts, keep their accounts secure, and think long term.
  • Bitcoin's dramatic price rise since its 2009 debut is attracting both institutional and individual investors.
  • Visit Business Insider's Investing Reference library for more stories.

Bitcoin is possibly the most fashionable investment of the past decade. It has appreciated in value by anything from 717,900% to just shy of one billion percent (depending on your starting figure) over the last 10 years or so. Either way, it's one of the best-performing financial assets in recent history.

But while bitcoin is certainly the talk of the town, much of it remains shrouded in mystery. It's not clear to newcomers how best to invest in the cryptocurrency, with banks and most mainstream brokerage platforms refusing to handle it. Plus, its price swings can be frighteningly volatile by the standards of traditional stock and bond markets.

Let's demystify how to invest in bitcoin: the various places to buy it, the risks and rewards, and strategies for safely ensuring a higher return.

Why invest in bitcoin?

Bitcoin is a cryptocurrency, a form of private, electronic money whose transactions are validated using cryptography, the science of encrypting and decrypting information. Since its launch in January 2009, it has come to be traded amid the belief that its software-enforced cap to 21 million bitcoins will ensure that it only appreciates in value over the long term.

"The best argument for Bitcoin's future success is the same argument long used for gold, diamonds and collectibles: It has been designed to have a limited supply and cannot be counterfeited," says Bob Fitzsimmons, the executive VP of Fixed Income, Commodities, and Stock Lending at Wedbush Securities.

The appeal of bitcoin's 21-million finite supply became more pronounced in the context of the 2020 coronavirus pandemic, which has brought record-low interest rates and "unprecedented levels of fiscal stimulus," says Fitzsimmons. 

But even before the COVID-19 pandemic, bitcoin has enjoyed significant longer-term price increases. Having been worth around $1 at the beginning of 2010, it reached a new all-time high of $23,770.85 on Dec. 17, 2020.  

It hasn't been a smooth ascent, though. Over the years, the cryptocurrency's price has bounced all over the place, sometimes plunging by hundreds of dollars in hours. It hit an all-time high of $19,783 in December 2017, too — before falling over the next couple of years by thousands. In fact, in  November 2020 it crashed by $3,000, before climbing again.  

Given such price swings, bitcoin can be loosely classified in the same investment league as growth and tech stocks, which have provided investors with higher-than-average returns, in exchange for taking on higher-than-average risk.

Buying and investing in bitcoin

Assuming that they're willing to accept the risk, investors interested in buying and investing in bitcoin have a number of options at their disposal. Each has its own advantages and disadvantages.

Bitcoin trusts and funds

For those who aren't keen on the idea of actually handling or owning bitcoin themselves, one simple option is to buy shares in a publicly traded bitcoin trust. Similar to ETFs or mutual funds, these offer a portfolio that holds or trades the currency. 

"The easiest way to buy bitcoin is through the Grayscale Bitcoin Trust (GBTC) because it tracks the cryptocurrency and trades via the traditional financial market," says Ari Wald, the MD of the Institutional Portfolio Strategy team at Oppenheimer & Co. However, partially for this reason

Besides the Grayscale Bitcoin Trust (which is by far the largest), other bitcoin trusts or funds include:

  • ETC Group offers an "exchange-traded cryptocurrency" product that tracks bitcoin and is listed on the Deutsche Börse XETRA.
  • 3iQ's Bitcoin Fund, listed on the Toronto Stock Exchange.
  • CoinShares has several bitcoin tracker funds listed on the NASDAQ/OMX exchange in Stockholm.
  • Wisdom Tree owns a physically-backed bitcoin exchange-traded product listed on Switzerland's SIX exchange.

The main catch, in return for the convenience: Fees for funds and trusts can be fairly high. The Grayscale Bitcoin Trust charging an annual management fee of 2%, for example. Like others, it "also trades at a substantial premium," relative to the value of the bitcoins it holds, Wald notes. 

Financial and investment apps

Recently, there has been a small number of financial and investment apps jumping into the cryptocurrency fray.

For example, take PayPal, which in November began enabling its US customers to buy, sell, and make purchases with bitcoin, as well as three other cryptocurrencies (ethereum, bitcoin cash, and litecoin).

"The biggest obstacle [for bitcoin buying and selling] has always been having to open an account with a bitcoin exchange and providing documents to verify your identity. Because hundreds of millions of people already have PayPal accounts, they can skip all of that hassle," says Glen Goodman, an investment expert and author of The Crypto Trader.

However, there are downsides to buying bitcoin with PayPal: "You can't move your bitcoin to your own personal wallet or send it to anybody else. You can't transfer it to a crypto-exchange to use it for trading other cryptocurrencies, Goodman notes. "There are also relatively large fees" for transactions, ranging from 1.5% to 2.3%, depending on the amount you buy or sell.  

PayPal isn't the only mainstream app cashing in on the crypto craze. The popular investment app Robinhood is also dealing in the currency now, and it doesn't charge any commission.

Square's Cash App is another platform that includes bitcoin trading, while Swan Bitcoin is an app that lets users automatically invest in the cryptocurrency at regular intervals. Square does usually charge service and volatility fees for bitcoin transactions (although it doesn't explicitly state what these are on its website), while Swan Bitcoin charges from 0.99% to 2.29% as a percentage of the weekly amount saved. 

Cryptocurrency exchanges

One of the main ways investors purchase bitcoin is through cryptocurrency exchanges. Since this option involves  directly buying bitcoin yourself on a dedicated cryptocurrency exchange, it's recommended for more experienced investors.  These have certain advantages over the apps and funds, such as:

  • Lower fees in the range of 0.10% to 0.26% 
  • The ability to withdraw bitcoins and download them to another account. This is considered essential by many experienced bitcoin traders, given that various high-profile cryptocurrency exchanges have suffered hacks over the years. (Some apps do allow it, but popular ones like Robinhood and PayPal are not among them.)

As mentioned, this is a more sophisticated game — you're getting into the professional traders' territory. Still, "if you're a more advanced user, then you can probably handle buying on an exchange yourself," says Samson Mow, chief strategy officer of blockchain tech firm Blockstream. "Bitstamp or Kraken are reliable platforms" that he recommends for individual investors.

Other reputable exchanges operating in the US include Coinbase, Binance, and Gemini. 

To start trading, you'll have to open an account with the exchange. These exchanges follow stringent know-your-customer (KYC) guidelines, so you will need to prove your identity before being able to trade using them. Most exchanges have minimum deposit requirements for fiat currencies and cryptocurrencies, but these are usually very low.

What to know before investing in bitcoin

Despite being over a decade old, bitcoin remains a relatively immature asset. There's less trading volume on its markets, which means it's less liquid, and the price changes can be volatile.  It's therefore hard to predict how it will behave from one month to the next. 

Here are some tips for reducing your exposure to risk while also increasing your exposure to potential gain.

Keep it safe and secure: Crypto-exchanges still continue to suffer the occasional hack even today, so seasoned bitcoin investors own their own digital wallets. A hardware wallet is a handheld, offline device that securely stores the private key necessary to transfer your bitcoin holdings from one place to another. Ledger and Trezor are two reputable brands. 

 "If the amount you store is going to be a lot, you may also want to add a seed backup," advises Mow. A "seed backup" is a backup of the phrase (i.e. a set of words) that lets you access your bitcoin wallet. Many investors holding large quantities of bitcoin engrave their seed phrases onto metal plates and then store these plates somewhere safe (such as a bank deposit vault).

Likewise, you should plan on doing all of your investing from a secure internet connection. In general, trading or buying bitcoin on a public WiFi network makes you more susceptible to attacks from hackers. 

Start small, rather than big: Given its short history and still highly unpredictable behavior, it's usually wise to keep your initial investment in Bitcoin relatively limited. Even experienced investors (e.g. hedge fund manager Paul Tudor Jones) have allocated just a single-digit percentage of their capital to bitcoin while keeping the rest in less volatile assets. And, despite the hype and forecasts, maintain your investment discipline, buying only what you can afford to potentially lose and not getting swept up by promises of gigantic upswings.

Bear taxes in mind: Even though it's a currency, the IRS considers bitcoin to be property rather than money, so it's subject to the same tax treatment as other investment assets. Bitcoin taxes can be triggered by trading, exchanging, or simply spending the cryptocurrency (if it's increased in value since you bought it). So documenting every transaction is essential. The good news is that bitcoin profits are taxed at the special capital gains tax rate, which is often less than ordinary income rates.

Have a buy-and-hold mentality: Unless you're prepared to watch the market daily and move at a moment's notice, investing in bitcoin should really be undertaken for the long term. "Bitcoin's heightened day-to-day volatility makes this especially true," says Ari Wald. 

In other words, it's not really advisable to buy bitcoin expecting to sell it a day, week, or month later, as investors found when the cryptocurrency tanked by 50% in two days in March. However, the fact that bitcoin recovered following this crash to hit a new all-time high in November and then December shows the virtue of patience. 

The financial takeaway

The investment outlook for bitcoin is bright. It had an exciting 2020, with a growing number of corporate investors beginning to snap up the cryptocurrency (a big part of the reason why it has risen in price by 170% since 2019). 

And with more institutional investors buying bitcoin every month, and the cryptocurrency's relative supply shrinking, most analysts seem to think it still has space to rise higher.

Not only has the future never looked better for bitcoin, but it has never been easier to buy and invest in the cryptocurrency. From payment apps to bitcoin funds to crypto-exchanges, there are now a multitude of options for anyone wanting to gain exposure to the original all-digital asset. 

Related Coverage in Investing:

Capital gains are the profits you make from selling your investments, and they can be taxed at lower rates

Alternative investments are exotic assets that can diversify your portfolio — here are the five major kinds and everything you should know about them

What are liquid assets? A guide to the investments that are easiest to cash in, and why they're important

How to diversify your portfolio to limit losses and guard against risk

'I have changed my mind': A top market strategist and long-time crypto skeptic explains why he now believes bitcoin should be in investor portfolios

 

Source: Read Full Article