Welcome to the Wild Wild West of Crypto Currency
The world of digital assets (also known as crypto-assets) broadly refers to — cryptocurrencies, coins or tokens. These exist in the new intangible digital world and usually have no physical assets backing them, and as such you rely upon a digital assignment of value and the right of ownership.
They digitally represent your ownership of a value or rights to something and they're usually not backed by physical assets.
That said, digital assets are here to stay, but where do they fit in your digital life, and your financial life? While you can buy digital assets, investing in them brings a whole new conversation - and nobody wants to ask, 'What happens to your money if something goes wrong?'
Read in this article
- FOMO (The Fear of Missing Out) and the Wild Wild West Frontier
- 1. Ask yourself, 'What's the state of my financial foundation?'
- 2. Ask yourself, ‘What’s my purpose behind purchasing crypto?’
- 3. Ask yourself, 'What is my current risk appetite?'
- 4. Ask yourself, ‘Have I done enough research?’
- 5. Ask yourself, ‘How well do I understand the potential risks?’
- 6. Ask yourself, ‘What’s my investment philosophy, strategy, and exit plan?’
- Where to from here?
FOMO (The Fear of Missing Out) and the Wild Wild West Frontier
The world of digital assets—cryptocurrencies, NFTs, and decentralized finance—were the hottest topics of 2020’s. The media loved a good crypto story (and the bad) and with that new level of perceived familiarity, with this digital asset class came a fear of missing out on the next best thing and, for many people without an investment plan, a rush to ‘get into crypto' and work out the details later, just in case.
So should you include them in your investment plan? There are a lot of half-truths, questionable truths, and personal decisions to unpack, so before putting money into digital assets start by asking a few key questions.
Pro Tip: Perhaps start from the premise - 'Am I Investing or Speculating?' - both are fine as long as I’m honest with myself first.
1. Ask yourself, 'What's the state of my financial foundation?'
Avoid putting your eggs in one basket. Investing in a relatively new type of asset class has additional risks to manage, so before taking on additional levels of risk to your money, make sure your financial basics are covered.
A strong financial foundation consists of a
- robust emergency fund,
- a backup plan for your mortgage debts, and
- income-earning potential,
- a Will, and
- Power of Attorney in secure document storage,
- no significant high-interest debts,
- an up-to-date beneficiary nomination in your superannuation fund, and
- any a written list of other financial goals you’ve decided to work towards.
Insight: Digital assets can come with a significantly higher amount of risk than traditional investments, so you want to ensure you have a foundation that can bear that volatility and risk. Don't be caught arguing about 'the pros and cons of crypto currency' investing for yourself, until you first have a plan for your money. It's like arguing about the pro and cons of blood pressure medication – before you have given up smoking.
2. Ask yourself, ‘What’s my purpose behind purchasing crypto?’
Always have a plan for your money. Before making any investment, you need to have a purpose for your investing because the purpose will guide your approach to the investment and save you from making rushed decisions during stressful times. If you’re investing in cryptocurrency for the long term, and believe in the overall movement, the day-to-day volatility won’t be as difficult to weather
3. Ask yourself, 'What is my current risk appetite?'
Make sure you know what your current investment risk appetite is and what type of investor you are. Make sure any new investment risk and volatility are within your expectations (otherwise sleep is not the only thing you risk losing).
While seeing headlines about teenagers making easy millions can give anyone FOMO, a desire to get-rich-quick isn’t an appropriate investment strategy. Always be guided by your true purpose.
4. Ask yourself, ‘Have I done enough research?’
A classic piece of investment advice is to only invest in things you understand. Because the cryptocurrency space is still expanding, many digital assets lack the extensive history and broad background information about their performance, reliability as an investment, and any pending government regulation risks.
Beginning research includes researching the history of the coin. This would include research on the team behind its development, the asset’s purpose and utility, the support it has received from investors, the price history, direct competitors, and overall market cap.
While you can do your own research on certain cryptocurrencies, it’s worth noting they lack institutional backing and the traditionally expected behaviours of traditional tangible investment assets. There aren’t balance sheets or technical analyses from investment firms for you to compare and there isn’t extensive price history to base projections on.
As such, these investments are considered high-risk, which leads to the following question Number 5…
5. Ask yourself, ‘How well do I understand the potential risks?’
Cryptocurrencies are unique digital assets that come with many different layers of risk.
- Regulation risk – There's no centralised regulatory body to oversee crypto-assets such as cryptocurrency, tokens, or stablecoins, and while some view this as a good thing, it really means that investors are unprotected. The Australian government’s regulator ASIC is actively working to create regulations around cryptocurrencies.
Pro Tip: Since many crypto investors are drawn to the asset class because of the lack of regulation, government efforts to regulate digital assets could have a negative impact on their return.
- Security risk – These are digital assets, and many are vulnerable to cyber hacks, scams, and targeted sophisticated phishing activity. You’ll need to be aware of all the ways to safeguard your investment, and these may be different than anything else in your investment portfolio.
- User risk – The current state of buying and selling crypto-assets is not yet user-friendly. One mistaken keystroke, and you’re sending money into the void, never to be found or returned. Taking the time to learn the basics and understand how different pieces of the crypto puzzle work, is highly recommended before making investments.
6. Ask yourself, ‘What’s my investment philosophy, strategy, and exit plan?’
What would you do if your crypto investments tripled in value in the first month? What if it lost 95% of its value in the first week? Your investment philosophy and investment strategy should provide the answers.
Here’s a hypothetical example, showing how an investor might think about a crypto investment philosophy and investment strategy:
An investor decides they want to put money in crypto but, because there are so many different investment options, they opt for the two coins with the largest market cap - Bitcoin and Ethereum. They believe crypto adoption is only in its infancy, so they want to hold for five years before evaluating whether it makes sense to sell. If they come out on top, any profits will be used for a long family holiday.
Within a year, the crypto market crashed, and their investment was worth half as much as when they started. Rather than selling, they revisited their investment plan and stuck to it. The following year, crypto entered a bull market that ran well past the five-year window. However, the investor reviewed their strategy at the five-year anniversary and saw that the portfolio had gained enough to pay for a two-year holiday even after the taxes on the gains were paid. They sold out and moved on.
Now, they could have seen the ongoing bull market and stayed invested, but that would’ve gone against their initial investment strategy, and the market could’ve dropped the next day, wiping out all returns.
- With how fast the digital assets space moves and new investments appearing, not having an investment strategy in plan ahead of time can lead you to invest outside of your comfort zone.
When making individual investment decisions, it’s important to have a plan for your money, stick with your investment philosophy - whatever it may be, and only change course when necessary.
Where to from here?
There’s a lot to think about when it comes to investing in cryptocurrencies. While many believe investing in digital assets is still the ‘wild wild west frontier’ of investing, traditional investment principles still apply. Always understand what you’re investing in, take your own personal situation into account, and ask yourself a few of these questions before making an honest investing decision.
Call us today on 1300 137 403 or email us here for a no-obligation private chat about your situation.
Drew Browne is a specialty Financial Risk Advisor working with Small Business Owners & their Families, Dual Income Professional Couples, and diverse families. He's an award-winning writer, speaker, financial adviser and business strategy mentor. His business Sapience Financial Group is committed to using business solutions for good in the community. In 2015 he was certified as a B Corp., and in 2017 was recognised in the inaugural Australian National Businesses of Tomorrow Awards. Today he advises Small Business Owners and their families, on how to protect themselves, from their businesses. He writes for successful Small Business Owners and Industry publications. You can read his Modern Small Business Leadership Blog here. You can connect with him on LinkedIn. Any information provided is general advice only and we have not considered your personal circumstances. Before making any decision on the basis of this advice you should consider if the advice is appropriate for you based on your particular circumstance.