There are two types of thinking when it comes to investing in cryptocurrencies. The former says it cannot mitigate risk in cryptocurrency, as it is considered one of the most volatile asset classes on the market, no matter what specific currency or listing it invests in. The second says you can diversify your portfolio by looking at the underlying. cryptocurrency does. This is an area where you want to consider the basics more than the chart. Here’s what you need to know about the allocation of cryptographic assets in 2022.
A financial advisor could help you create a financial plan for your cryptographic investment needs and goals.
Don’t miss out on news that could affect your finances. Get news and tips for making smarter financial decisions with SmartAsset’s biweekly email. It’s 100% free and you can unsubscribe at any time. Sign up today.
Four main types of cryptography
Before you invest, you should know that there are four main types of cryptocurrency. Here is a breakdown:
Pure currency. This is what is known as pure cryptocurrency, sometimes called “currency”. These include assets like Bitcoin that are meant to function as money and a reserve of value. The underlying software does nothing but record and execute transactions. This has made currencies very popular as an investment asset, as they have no function in distorting their commercial value.
Despite the enormous value of cryptocurrency (with a market capitalization of $ 1.7 trillion in May 2022), no economy has successfully adopted any cryptocurrency as a functional form of money. Nor is it likely that, as it is currently conceived, any economy will. One of the reasons, among many, is the huge energy costs.
Currently, the Bitcoin network alone consumes about 93 terawatt-hours per year to process about 102.2 million transactions worldwide. Increasing these numbers, replacing the 39.6 billion credit card transactions generated by the United States alone each year would require the Bitcoin network to consume 36,070 tera-watts of electricity. This is almost nine times the amount (4,116 terawatt-hours per year) generated and used across the country.
Stablecoins. Stable currencies are cryptocurrencies intended as pure currency, but which are also regulated by some underlying company or project so that they maintain a consistent price. Many, if not most, stable currencies keep their price at $ 1 per token. The highest profile project in this space is Tether.
The idea behind a stablecoin is that it offers cryptocurrency users a reliable value reserve. Pure currency assets tend to fluctuate a lot in price. This can turn into a good speculative investment, but it makes it almost worthless to spend. Stable currencies offer relatively few profit opportunities, as by definition their price is fixed, but they do offer a way to move your money to cryptocurrency without volatility. They are usually a popular way to keep money in cryptocurrencies until you want to buy some other potentially lucrative asset.
This is especially useful for tax purposes, as you can sell other cryptocurrencies without the need for profits or losses in dollars.
The problem with stable currencies is that they require enormous liquidity to maintain that price stability, and recent research has revealed that even the most important names in this space may not have the assets they claim. In addition, the management involved in regulating the price of a stablecoin often touches on market manipulation, which has begun to draw the attention of U.S. Treasury and SEC regulators.
Safety data sheets. Tokens are assets built with a blockchain database, such as pure cryptocurrencies. In this sense, they are the same basic asset. However, unlike monetary cryptocurrencies, often called “currencies”, tokens are built for a purpose other than spending.
There are two main types of chips on the market. The first type is the safety data sheets. These are financial securities released by companies as investment assets, unless you receive a digital certificate of ownership instead of any physical asset.
A company will typically issue security tokens in what is known as an initial coin offer (ICO) to raise capital for its project. Most security tokens take their value from the fact that they give you some sort of access to the company’s underlying project, overlapping with utility tokens (see below). For most security tokens, this access determines the value of the asset. The more successful your business project is, the more people will want to use it. This will increase the value of the tokens that give access to this project, from which investors can benefit.
However, it is important to understand two things about the security card market. First, this is a scam-dominated asset class. In recent years, some industry analysts have estimated that approximately 80% of all security token offerings were fraudulent. Second, the legal status of security tokens remains undetermined. The SEC continues to study this field, while cryptocurrency companies simultaneously offer their tokens as investment assets while arguing that their tokens are software rather than securities.
Utility sheets. Utility tokens are tokens in which the underlying software has some function or purpose other than to register ownership. Two common ways to operate utility tokens are by encrypting the blockchain database to run basic commands and getting people to spend tokens to access other software.
For example, the popular software platform Ethereum uses its tokens to execute what it calls “smart contracts”. This means that you can schedule basic contracts directly in the database itself. You can create a software platform for deliveries, where the software automatically transfers payment from someone’s bank account as soon as the packages are scanned, for example.
On the other hand, many blockchain enthusiasts have introduced the idea of ”distributed computing.” Under this model, you can use tokens to access the server or storage space. Someone could buy tokens and spend them in exchange for time using your server’s processing power. In any case, the point of the token is to access some functionality.
There is a significant overlap between security tokens and utility tokens since, at the time of writing, all companies with utility tokens have released such tokens as an investment asset. At the same time, no company has released a commercially available product based on utility chips or other blockchain-based software.
Utility tokens may not exist either. The SEC says any listing traded for investment and released specifically for the purpose of raising capital is a financial security. Since this is the underlying business model of all blockchain-based businesses, the market should change significantly for utility tokens to emerge as a functional asset.
How to apply these asset classes
As with all portfolios, the best way to invest in cryptocurrency is to diversify. If you have all your money in one asset, you can make a lot of money with the maximums. But you will also be exposed to all the bass. Since the crypto market is hugely dominated by a single asset, this means that you should try to invest in something other than Bitcoin.
Overall, three good assets to diversify your portfolio include:
Ethereum: If there’s one cryptographic project that has real value, it’s Ethereum. This is open source software and the most popular platform for building other blockchain projects.
Ripple: Ripple’s token is XRP. This is a project focused on the financial services space. The goal is to create a cryptocurrency that can facilitate transactions between banks and other financial services, a project with more articulable value than many others in the cryptocurrency space.
Litecoin: This is a cryptocurrency, so it is intended as a monetary project. It has a much smaller energy footprint than Bitcoin, making it potentially more useful for spending. It is also less volatile, although in this market this is a relative statement.
In addition to these three assets, you must base your cryptocurrency allocation on a combination of risk and fundamentals management. Here are three additional assets that follow that criteria:
Monetary currencies: Cryptocurrencies are often the most volatile assets in this space. If you are looking for an investment with higher upside potential, at the expense of higher risk, you should increase the portion of your portfolio dedicated to pure currencies.
Stable currencies: Stable currencies are a good place to park your money during a turbulent market. If you expect problems ahead or are unsure of what to invest in right now, stable currencies are often a good way to eliminate volatility without leaving the market.
Sheets: Security / utility tokens are often the most predictable assets in the cryptocurrency space, although we understand that we use that term vaguely. You can analyze a security token based on the fundamentals of the underlying project, giving you a way to understand the risk beyond pure market restlessness. If you want to mitigate the risk, this is your measure.
The best way to understand the allocation of assets in your cryptocurrency portfolio is by learning the basic classes of cryptocurrency assets. If you want high risk, invest in pure currency projects. If you want to mitigate the risk, consider the basics of security tokens. If you want to wait for the market, look for stablecoins.
Investment Tips for Beginners
A financial advisor can help you put a financial plan into action for your cryptocurrency investments. The free SmartAsset tool combines you with up to three financial advisors who serve your area, and you can interview your advisors at no cost to decide which one is right for you. If you are ready to find an advisor to help you reach your financial goals, start now.
If you’re thinking of adding cryptocurrencies to your portfolio, here’s what you need to keep in mind for long-term investing.
Photo credit: © iStock.com/Credit:sittipong phokawattana, © iStock.com/ipopba, © iStock.com/oatawa
The publication Cryptographic Asset Allocation: The 2022 Investment Guide first appeared on the SmartAsset Blog.