Hackernoon logoBuying bitcoin for the First Time? Start Here by@DataGeneralist

Buying bitcoin for the First Time? Start Here

Steven Finkelstein Hacker Noon profile picture

@DataGeneralistSteven Finkelstein

Data analytics generalist. I publish notes, lessons, and tools for data analytics and investing.

Utter the word, “Bitcoin”, in any conversation and you can have the entire room at your immediate attention. Not many words or phrases have that kind of power in society. At 12 years of age, this pre-teen is just about to enter its rebellious stage. Subscribing to the Lindy effect, it is more likely than not that Bitcoin will last another 12 years. Can you handle this craze for another 12 or more years? More importantly, could you survive the FOMO if you do not invest at least a little bit of money into crypto?

To be clear, I’m not here to explain what Bitcoin or cryptocurrencies are or whether you should invest in them. That subject could be an entire dissertation and, frankly, I am unqualified (website disclosure). Instead, I will outline the important decisions and options to get started investing in crypto assets, should you decide to join the party. Within this guide, will be a steady stream of links to help you learn more about crypto and blockchains. Having a decent understanding of the crypto space is highly recommended before investing in these assets.

Getting Started With Bitcoin

To get started on this journey, I’d recommend this fun, cute video where a 3-year-old explains Bitcoin. Understanding the social media and entertainment aspects of crypto is just as important as the economic ones. Some Bitcoin bulls claim it will be a success because it is a religion, while others find the most appropriate metaphor is a city. Personally, I find the most enlightening discussions involving crypto highlight the importance of networks. Patrick O’Shaughnessy, CEO of O’Shaughnessy Asset Management, does an incredible job untangling this relationship through several lengthy discussions on his Invest Like the Best podcast. They are a few years old, but I find that most of the material holds up well, which is a testament to their value (links below).

Hash Power Episode 1 – Understanding Blockchains

Hash Power Episode 2 – Investing in Cryptocurrencies

Hash Power Episode 3– Funding, Forking, and a Creative Future

Quick Crypto Definition Cheat Sheet

  • Altcoin– an alternative digital currency to Bitcoin. The word Altcoin is a portmanteau of “alternative” and “coin”, to form “altcoin”
  • Blockchain– a system in which a record of transactions made in bitcoin or another cryptocurrency are maintained across several computers that are linked in a peer-to-peer network.
  • Cryptography– the art of writing or solving codes
  • Decentralize– to distribute the administrative powers or functions of (a central authority) over a less concentrated area
  • Fintech– “financial technology”, the technology and innovation that aims to compete with traditional financial methods in the delivery of financial services.
  • Hash rate– the measuring unit of the processing power of the Bitcoin network
  • Satoshi– the smallest unit of a bitcoin, equivalent to 100 millionth of a bitcoin, named after the founder of Bitcoin, Satoshi Nakamoto

How Can I Invest in Crypto?*

There are two methods for investing in crypto: direct and indirect exposure. The primary method for gaining direct exposure involves purchasing cryptocurrencies or a fraction of them. For example, you could purchase 100 Satoshis of Bitcoin to gain direct exposure. Purchasing cryptocurrencies directly is the highest risk (AKA variance) method for gaining exposure to this asset class. In general, the more exposure you have to cryptocurrencies, the higher the risk.

If you are interested in a lower-risk option to gain exposure to the crypto asset class, you can invest in stocks. Some stocks are significantly impacted by cryptocurrency demand. If cryptocurrencies go up in value, these stocks are highly likely to follow the same directional move. This includes crypto mining companies, crypto exchanges, fintech companies, semi-conductors, and companies with Bitcoin on their balance sheet (e.g. RIOT, Microstrategy/MSTR, Paypal/PYPL, Nvidia/NVDA, Voyager/VYGVF, etc.). In the image above, these stocks appear in the upper central and upper left regions. If you don’t know which company to choose, you might consider purchasing a crypto/blockchain-themed ETF that holds a portfolio of these companies (e.g. BLOK, BLCN, and more). Technically, Tesla and NVDA are part of the S&P 500 so almost all individuals who own any equities are already indirectly exposed to crypto.

If you are too risk-averse to gain exposure through stocks or cryptocurrencies, there are websites and apps that pay users rewards denominated in crypto. Lolli is a browser plug-in that will track your shopping and give you Bitcoin rewards for purchases at certain stores. Fold pays you in Bitcoin rewards for purchasing digital gift cards through their mobile app. In addition to that, they let you spin a wheel (image below) to try and win free Bitcoin each day. If you spin for 7 consecutive days, you receive 500 Satoshis of Bitcoin for free. In the upcoming months, there will be credit cards released that distribute rewards denominated in cryptocurrencies. Fold and Gemini are two of the many companies coming out with Bitcoin-reward credit cards. These methods will land you in the lower right quadrant of the image above. Owning any cryptocurrencies is extremely high risk, but these methods ensure a smaller allocation relative to your net worth.

*This section is tailored to the average retail investor. I chose not to mention the bitcoin options market or altcoins because it’s targeted at beginners.

**Leaders by market cap size and based on sentiment in the crypto community.

† Technically, crypto credit cards, Fold, and Lolli give you cryptocurrencies. Therefore, they should be the highest level of risk. However, free rewards ensure a reasonable allocation, hence the subjective risk rating change.

Where Can You Purchase Crypto?

There are tons of options when it comes to purchasing crypto. While you can own your personal digital wallet or mine your own crypto, I would not recommend these options for beginners. It is much simpler to rely on a custodian to hold your assets. Most of the institutions that act as custodians fall under the following types.

How Do I Choose Which Institution to Purchase and Store My Crypto?

The framework for choosing the appropriate institution for crypto is similar to the one I recently published for choosing your IRA provider. The choice comes down to the following factors: Cost, Features, and Security.

Factor #1: Cost

The majority of exchanges charge a fee for each cryptocurrency transaction (i.e. purchase). Coinbase and Gemini charge a small set fee based on the size of the transaction, while Binance and Paypal charge a percentage-based fee for each transaction. Two exchanges that do not charge transaction fees are Voyager and Robinhood. Before you get excited about free trades, sometimes the fee is included in the quoted price of the cryptocurrency. Kraken follows this process for their free trades and explains it here.

Cost can also take form in terms of deposits and withdrawals. Some firms, like Binance, have withdrawal fees. In my experience, most exchanges do not have these fees or they are minimal.

Here is a good summary of transaction fees at various exchanges.

Factor #2: Features

Because this industry is young, features can be a significant differentiator for your crypto exchange selection. The most important feature is the flexibility to transfer your cryptocurrencies to other digital wallets. Some exchanges, like Robinhood and Sofi, do not currently allow users to transfer their crypto assets. This feature is critical because certain exchanges have a broader selection of cryptocurrencies, cheaper fees, or will pay you interest on your assets. If you want to take advantage of features on other exchanges, you need the ability to transfer your assets. One of the primary benefits of blockchain and crypto is the ability to transfer your assets between digital wallets almost instantly. This is a stark difference compared to the multiple days it takes bank transfers.

Here is a good link to compare interest rates on cryptocurrencies at different exchanges. Please read the fine print before electing to earn interest on any of your cryptocurrencies.

Factor #3: Security

The only thing scarier than owning cryptocurrency is the idea of it being stolen. Because this space is not as regulated as traditional banks, holding these assets is riskier than storing cash in your FDIC-insured bank account. As an investor, you need to understand the likelihood of a hacker stealing your assets in a crypto exchange. While security has improved since the famous Mt.Gox hack in 2014, you should still tread carefully. Pay close attention to this section because SECURITY IS THE MOST IMPORTANT FACTOR for choosing an exchange.

There are three types of security features you can assess as a retail investor:

  • Security before a hack
  • Security during a hack
  • Security after a hack

Before a Hack

Before a hack, you should research the user authentication experience for each exchange. Most exchanges will have the option for two-factor authentication (2FA); however, SIM swaps are common enough to question whether this is sufficient. Authenticating your log-in credentials using a 3rd party random code generator or a security key would provide a little more comfort in protection. Most exchanges offer the more secure 2-FA options and I would suggest taking advantage of that feature at every institution where you store anything of value.

During a Hack

Should a hacker gain access to your account, you would hope there are features to provide another layer of defense. There are two primary methods to slow them down: Vaults and Whitelists. Some exchanges allow you to transfer your assets to vaults. They require additional approvals to move assets and forbid quick transfers. Whitelists allow users to restrict which digital wallet addresses an asset can be transferred to. Restricting addresses would prevent any quick transfers of assets from a hacker to another wallet. Adding a new digital wallet address to the list is a feature that is slow by design.

After a Hack

The worst-case scenario just happened! A hacker got access to your account and was able to steal all of your assets. Sadly, cryptocurrencies are not FDIC or SPIC insured. That means you have no protection from the federal government, should someone steal your assets or if the exchange goes bankrupt. Fortunately, some exchanges hold most of their assets in cold storage (i.e. offline- not connected to the internet). For example, Coinbase states that they hold 98 percent of their assets in cold storage and that they have insurance for the 2 percent in hot storage. Gemini is seen as one of the most secure institutions because they are classified as a trust. Therefore, they adhere to strict fiduciary capital reserve and cybersecurity standards by the New York Department of Financial Services. Gemini provides a summary of their security practices here.

This article provides a good overview of recommended personal cybersecurity tips.

How Much Should I Invest in Crypto?

Cryptocurrencies are one of, if not, the most volatile asset you can purchase as a retail investor. Because of its volatility and lack of history, most financial advisors would advise proceeding with extreme caution. Because of the high risk, I would consider only allocating a small percentage of your portfolio. Nick Maggiulli, a data scientist at Ritholtz Wealth Management, provides a good data-driven analysis that suggests 2 percent could be an optimal choice. However, this analysis was done in 2017 so I would suggest using the number solely as a starting point in your research.

To prevent human biases from influencing your process, many financial advisors adhere to dollar-cost averaging for purchasing assets. A simple rule would look like the following:

I will purchase “X” dollars of Bitcoin, or another crypto asset, every “Y” weeks until it becomes “Z” percent of my portfolio.

Fill in “X”, “Y”, and “Z” with your personal preferences after doing some research. This automated process is simple, but it protects you from mistiming the market and guarantees that you purchase more of an asset when it hits lower prices.

Final Note

Investing directly or indirectly in cryptocurrency exposes you to higher risks. These risks are apparent in the increased volatility of the assets, as well as, the increased counterparty risk because there is no insurance coverage from the federal government. The difficulty of the subject matter only adds further complexity. Before you invest in this space, I would highly recommend you continue learning about cryptocurrencies and blockchains (resources listed at the end). Once you can explain Bitcoin better than Lily Knight and you understand all of the risks, only then, should you consider investing in this asset class.

The Data Generalist

Additional Learning

If you are interested in diving into the bottomless crypto rabbit hole, here are some recommended resources to target next in your learning journey.

  • Satoshi’s Bitcoin whitepaper that began the Bitcoin revolution
  • The Case Against Bitcoin
  • Michael Batnick and Ben Carlson, two wealth management professionals, interview BlockFi CEO, Zac Prince
  • Introduction to altcoins
  • Popular crypto podcast, Defiant, interviews Mark Cuban about DeFi (Decentralized Finance), Bitcoin, Ethereum, and NFTs
  • An introduction to NFTs, non-fungible tokens
  • Bitwise started the first DeFi crypto index
  • Top Shot, sells licensed NBA digital collectibles
  • Messari, one of the top crypto research websites
  • Crypto news and newsletter at Blockworks

Disclaimer: Long BTC, ETH, LINK, ZEC, UNI, SQ, PYPL, IPOE/SOFI, NVDA, VYGVF, VOO.

Disclosure: Disclosure applies to my articles published on Hackernoon, too.

Image Sources:

  • Woman holding coin: Unsplash
  • Fold App: Author screenshot
  • Brokerage Table: Author
  • Risk Exposure Matrix: Author

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