7 Basic Things You Need to Know Before Investing in Cryptocurrency

So you’ve decided to hop onto the bandwagon and invest in the wild wild west of investments – cryptocurrencies. With the latest tax rules now clarifying many of the cobwebs around crypto investments, now is as good a time as any.

Here are the seven basics that you need to know before diving in, ready on a platter for your consumption:

1. KYC - Know your coin:

There are more crypto coins than you can invent out of thin air, at this point. Not all of them are worth investing in. Though all cryptocurrencies are built atop the same blockchain technology, there are nuances that distinguish each one. Some ways in which they can differ are:

In the end, it is a choice that you will have to make, but take care that you weigh all these factors before investing in cryptocurrency, says the author (Photos for representational purpose only)

• Whether there is any limit on the total number of coins that can be produced: For example, bitcoin has a hard stop at 21 million, out of which 18.8 million are in circulation currently.

• Whether it is accepted as a valid currency: Currencies like Binance have built-in uses like paying fees on the Binance exchange, while BitCoin has increasingly gained acceptance for peer-to-peer payments.

• Whether its value is purely demand vs. supply: Pure cryptocurrencies like BitCoin and Ethereum have no inherent value and derive their price from the demand and supply dynamics surrounding them. However, there are other coins, also called ‘stablecoins’, whose value is anchored to ‘real’ currency. Tether, for example, is anchored to the US Dollar.

• Any other technological innovations: There are various ‘superpowers’ that some coins, or rather the technologies that they run on, have. Some are known for being environmentally friendlier than others, while some are faster and more efficient.

In the end, it is a choice that you will have to make, but take care that you weigh all these factors before choosing.

2. A good wallet will keep you safe:

Unlike a normal wallet that holds your cash, a crypto wallet doesn’t hold your cryptocurrencies. Instead, it holds something called a ‘private key’ – a piece of information that proves your ownership of your coins.

Think of it as the key to your house. If this key is lost, though you still own every object in your house, you cannot access any of them, nor can you sell them. It’s there, but for all intents and purposes, it’s lost. Choosing a good wallet for your private key will ensure that you’re always able to access your crypto investments and sell them if required.

Broadly, there are two types of wallets – hardware and software. The hardware wallets (also called cold wallets) are like pen drives, and need to be physically inserted when you need to use your key.

As you can imagine, it is both secure (since it cannot be hacked), and cumbersome to use. Instead, most people use software wallets, like the CoinBase wallet. Though riskier than the hardware wallets since they are open to malicious attacks, they are the much-preferred route because of the convenience they afford.

3. The right exchange will maximize your gain:

So, once you’ve finalized which coin you want to invest in, and you have a wallet set up with your private key, you are now ready to start investing. Like stocks are traded on stock exchanges, there are some exchanges that allow you to trade cryptocurrencies.

There are exchanges for trading in cryptocurrency, but the fees can usurious

For this facility, they charge you various types of fees. Unlike the stock markets, which have matured over the years, the crypto market is still very new, and the fees can be usurious.

So, when you’re selecting the exchange, look into not just the fact that they offer the currency you want to purchase with, but also that they don’t charge you an arm and a leg for the privilege of doing so.

4. There are other ways to attain cryptocurrencies:

You don’t necessarily have to buy cryptocurrencies. If you are strapped for cash but still want a piece of the action, there are ways – not great ways, but ways nonetheless. One of them is opting to learn from one of the platforms like Coinbase, in exchange for which they will reward you with currencies.

There are also events called ‘airdrops’, in which developers directly transfer coins to some select investors, to popularize their new coins. However, a word of caution – these are ripe for being exploited by hackers and fake airdrops are prevalent.

You can also mine cryptocurrencies, which is a tedious but safe way to generate some bitcoin. Use an online profitability calculator like NiceHash first, to ensure that you’re ending up generating something of value after deducting all your electricity and other expenses though!

5. You can make more money off your cryptocurrencies:

Once you have successfully invested in (or been rewarded) cryptocurrencies, you can maximize your returns by putting the currencies to use while you’re holding on to them. One way is to lend your crypto in exchange for earning interest.

This way is fraught with risk however, since not only are you risking the inherent volatility of the crypto itself, but also increasing the risk of losing the crypto itself, since lending of crypto is not exactly a regulated field. Another thing that you can do is to ‘stake’ your crypto.

There are some coins that let you ‘stake’ your currency, through which you can earn a moderate return – 1.9% to 7% usually. There are no real risks to staking, and since there is no lock-in, it should be a no-brainer for anyone holding a stake-able coin. It would be akin to earning interest in your savings account, all for the grand effort of doing nothing.

Decentralized finance, of which cryptocurrencies are the biggest and best example, is the future in a global world

6. Taxation:

The latest budget has clarified the taxation of cryptocurrencies – the gain on them is, indeed, taxable @30%. But do note that it is only the gain that is taxable, so you can reduce the cost of acquiring the currency, before calculating the taxable portion. The clarity on the taxation aspect has bolstered sentiments in the Indian crypto market, since it implies some degree of acceptability of cryptocurrencies in the regulators’ minds.

7. Crypto communities:

Lastly, investing in cryptocurrencies has transformed from a purely monetary transaction to a social experiment. There is a substantial chunk of the investing populace that believes in the future of crypto – you are now one of them, and must join their online communities.

Since cryptos are so volatile and prone to everything from political risks to Elon Musk’s tweets, it will be immensely helpful to participate – even if passively – in these communities, to safeguard your investments, and also to earn an extra buck when the opportunities present.

The naysayers are right – cryptos have no inherent value. The crypto-heads are also right – decentralized finance, of which cryptocurrencies are the biggest and best example, is the future in a global world. The choice is yours, but armed with these seven basics, the choice would be a wise one!

Priyanka Mashelkar is Dy. Commissioner of Income Tax and Author, 15 Sure-shot ways to Hit the Jackpot