Mistakes of Investing in Cryptocurrencies
– How to Avoid Them?
NOTE: The following article is for review and educational purposes only. In no way should it be taken as investment advice suggesting specific actions to take in the cryptocurrency or other assets market.
Over the past decade, the cryptocurrency market has experienced rapid growth and has generated tremendous interest. The magic of Bitcoin and altcoins has attracted both experienced and novice investors. The crypto market, due to its innovation, represents a tempting opportunity for those who want to invest capital in assets that are an alternative to the world of traditional finance, i.e. the “gamble” of securities and the “boredom” of bank deposits. However, the universe of cryptocurrencies – just like the stock, bond or commodity markets – is governed by specific laws, without understanding of which we can rather forget about success. “I’ll buy cheaply, wait for bitcoin to grow to 100 thousand, one million or two, eventually sell expensively and become a rich man.” – unfortunately, it’s not as simple as it might seem.
It is absolutely crucial for novice investors to be aware of the mistakes that can be made when investing in cryptocurrencies. Their palette turns out to be really wide; potential stumbles are awaiting you at virtually every stage of investing. For example, acting on a wave of euphoric mood created by TV or social media, you may decide to make our first Bitcoin purchase at an extremely unfavorable time. Then you may fail to take proper care of the safety of the virtual assets during the storage and management period, and eventually sell all your tokens prematurely or too late under the influence of strong emotions. In today’s article, we will focus on the most dangerous, and most common mistakes, typically made by those starting out with Bitcoin and altcoins. We will also briefly describe how to avoid these mistakes. Let’s get down to specifics.
Mistake 1 – Lack of Education
One of the most common mistakes of freshly minted crypto-enthusiasts is to ignore the education and analysis stage before investing. The crypto arena is vast, with thousands of diverse tokens and the projects behind them competing for investors’ attention. Investing savings in virtual assets motivated by positive signals from the Internet and television or as a result of suggestions from friends seems natural. However, in reality, making major financial decisions without first trying to understand the mechanisms of the market and taking a close look at the players in it usually leads to a partial or total loss of money.
A rather huge mistake can be made at the very start of investing in cryptocurrencies. When is the best time to buy Bitcoin? – when its price is gliding like crazy towards the tops of the charts, or rather wait until it starts to slide towards the lows? The vast majority of crypto-novices will lean toward the first option for fear of missing the “opportunity of a lifetime.” “If I don’t join the game immediately, I’ll miss out on the big money, after all, there’s no indication that Bitcoin’s value is going to fall – everyone is buying, so I’ll buy too, immediately, because it’s only going to get more expensive.” – this all-too-common pattern of thinking is a guarantee of imminent disappointment. Why? Because the price of cryptocurrencies, like other assets, is shaped by cycles of alternating ups and downs. The period of extreme optimism, in which people buy Bitcoin en masse in the hope of an easy and sizable profit, is at the same time a moment in which the price of Bitcoin becomes increasingly exorbitant. The reason for the overvaluation is unnaturally high demand, meanwhile the laws of economics are inexorable: in such a situation (sooner rather than later) there must be a course correction. And that means value decline. When the media goes into hurrah-optimism, and Bitcoin is being bought by literally everyone on the streets, it means that we are already late to the market. It will be much more advantageous to be patient and make a purchase when the price starts to show a downward trend and stabilizes somewhat. We wrote about the dynamics of Bitcoin’s trading, which is significantly influenced by the halving mechanism, in an earlier blog article; an in-depth analysis of the issue is presented on the YouTube channel by Phil Konieczny.
For ignorance of the basic laws of economics, many crypto-novices come to pay dearly. Some people, devastated by the rapid drop in the exchange rate after making an expensive purchase, raise the white flag and withdraw from the virtual currency space in a panic. It is no coincidence that the popular slogan of the cryptocurrency community is Do Your Own Research, meaning research the topic before you start to act. For giants as well-established as Bitcoin and Ethereum the research is relatively simple – at a minimum option, it is enough to watch the stock market quotes, for example, on the website Coin Gecko, as well as occasionally follow news from the financial world to get an idea of which point in the business cycle the token of interest is currently in.
Research to optimize cryptocurrency market movements turns out to be more complicated when it comes to altcoins. In their case, a comprehensive look at the project issuing the token will be necessary. The analysis should include an examination of the technology underlying the cryptocurrency, the qualifications and achievements of the team leading its development, the practical applications of the token, and its growth potential. History has vividly shown how overlooking this important step leads towards the loss of money invested in cryptocurrencies that have no real value or, in the worst-case scenario, turn out to be simple scams. This is exactly what happened in 2017/2018 during the ICO (Initial Coin Offer) frenzy. Faced with the scourge of tokens rising like mushrooms, a huge number of investors have suffered severe losses, betting on projects with weak fundamentals or ideas that ultimately never came to fruition.
The potential return on investment in altcoins is much more impressive than that of Bitcoin, but at the same time it is burdened by incomparably higher risks. To avoid disaster, a novice investor should devote considerable time and effort to a detailed analysis of a particular cryptocurrency before buying it. Taking a look at the strengths and weaknesses of the project of interest, its market position and development prospects greatly increases the chances of choosing a valuable cryptocurrency with solid prognosis for the future.
Mistake 2 – Overinvestment
A very common mistake made by novice crypto-investors is to overestimate their financial capabilities. In other words, it’s a situation in which you allocate a disproportionate share of our budget to buy crypto. In extreme cases, the investment capital exceeds the limit of funds at hand – the practice of buying Bitcoin with money obtained from a bank loan or a loan from friends is unfortunately not uncommon. Acting rashly, novices simply ignore the fact that cryptocurrency quotes are characterized by extreme fluctuations. Declines and increases in value of up to 80% are not uncommon, and can just as easily translate into huge profits as lead to total bankruptcy.
Placing an exorbitant amount of money in an unpredictable market can result not only in financial disaster – the serious mental breakdown that usually accompanies it can be a much more severe repercussion. The emotional crisis caused by the loss of large sums of money sometimes initiates a spiral of self-destruction instead of discouraging further investment, in which the investor makes impulsive decisions in an act of desperation in an attempt to regain lost funds. In the world of finance, acting under the influence of strong emotions almost always makes things worse.Every crypto-enthusiast should rationally and carefully evaluate his or her individual financial situation, taking into account income, expenses, debt levels and savings, before finally determining the amount of investment in cryptocurrencies.
The optimal solution to avoid the trap of overinvestment is to allocate to crypto purchases only the portion of your budget that you can afford to lose without fear of getting into financial and emotional trouble. Colloquially speaking, raher careful approach will “cool you down” a bit. It will certainly reduce bitterness in the face of potential losses, and translate into making more sober decisions in response to rate fluctuations.
Mistake 3 – Lack of Diversification
Another mistake on the crypto investment path is the lack of portfolio diversification. Concentrating one’s holdings within a single cryptocurrency (e.g., Bitcoin) or in a narrow group of closely related tokens (e.g., Ethereum blockchain-based projects) exposes you to increased risk, as the performance of your portfolio will depend entirely on the success of a relatively limited number of assets. In the event that you select just one or two cryptocurrencies and they are the ones that score serious declines, your portfolio will be drastically depleted. As if that were not enough, excessive narrowing of the scope of assets held makes it difficult to make up for losses incurred. What would happen if you expanded our portfolio in advance with a few positions that record increases at exactly the same moment when the tokens you bought go down? Of course, your portfolio balance would end up with a less severe loses, and perhaps even paradoxically you would make some profits.
Diversification is a risk management strategy that is as old as the world and well-tested. Investing money in a diverse range of assets to minimize the effects of stock market downturns. Including cryptocurrencies with diverse uses and various technological profiles in the portfolio is an opportunity to increase the stability of investments, as well as open up new profit prospects. For example, you can allocate the lion’s share of one’s portfolio to the purchase of leading cryptocurrencies, namely Bitcoin and Ether, while investing more modest funds in promising altcoins or tokens associated with the thriving virtual services sector (e.g. NFT tokens).
In addition to diversifying within digital currencies, it is worth going a step further and considering diversification with other types of assets, such as precious metals, stocks, deposits or real estate. Such a broad-based strategy will further reduce the impact of cryptocurrency market risks on our capital.
Mistake 4 – Vulnerability to Fraud
Investment platforms offering 30% profit just for buying back Bitcoin from a customer? An exchange site that asks you to enter the seed phrase of your private wallet during registration? How about an incentive to buy crypto with cash and safely store Bitcoin in an account created by a professional advisor? Unfortunately, the universe of cryptocurrencies is full of scam.
Numerous scammers prey on the ignorance and inexperience of newly-minted crypto-enthusiasts. When entering the market for digital currencies, one must be on guard. The rapid development of blockchain technology, combined with the relative anonymity of transactions, has made the crypto space a breeding ground for all sorts of scams, including Ponzi schemes (financial pyramids), phishing attacks or fake ICOs. On an individual scale, falling into the snare of a scam most often means the irretrievable loss of money, while on a macro level it translates into undermining society-wide confidence in the entire cryptocurrency system.
Crypto-investors should be well versed in criminal schemes. Typical financial pyramids promise skyrocketing profits – the problem is that if you see them at all, they will come not from actual investment activity but from the deposits of other customers. In addition, they will be paid until, as an “incentive” to invest even more capital, after which, at some point, contact with company representatives will cease without a trace. Phishing attacks are another scourge, with scammers specializing in manipulating cryptocurrency holders to extort sensitive information such as private keys or login credentials. The criminals use the stolen information to steal funds stored on an exchange or in private cryptocurrency wallets. A common form of phishing is the creation of fake websites that mimic popular stock market portals in appearance. We have already mentioned the fraudulent ICO offers; fake start-ups tempt potential victims with visions of groundbreaking projects, then disappear with the funds raised before the token is issued, leaving capital donors empty-handed.
How to spot a scam before it’s too late? Beginning investors should exhibit a cautious and even moderately skeptical attitude towards all available cryptocurrency trading channels. The alarm light is automatically turned on in case of options that guarantee profit at fabulously exorbitant levels or generate a sense of pressure to invest capital as quickly as possible. In the course of verifying the credibility of various crypto-projects, it is worth making sure that recommendations about them come from reputable sources. In this regard, it proves extremely useful to consult experienced cryptocurrency users. Discussions in online forums – supplemented by knowledge drawn, for example, from thematic channels run by crypto-fans on YouTube – will help you dispel many doubts and expose numerous opportunity traps before you fall into them. Remember that vigilance combined with inquisitiveness greatly reduces the likelihood of becoming a victim of fraud.
Mistake 5 – Neglecting Security Issues
Let’s assume that we deftly bypassed the scam traps and managed to buy Bitcoin through a trusted source. Should we still be on guard? Definitely yes. Another mistake of investors entering the crypto market is the use of insufficient security measures to protect accumulated assets.
Thestrictly virtual nature of cryptocurrencies makes them particularly vulnerable to hacking attacks and malware. The most common threats are hacks of exchange accounts. You should also be alert to viruses that discreetly swap the public key while the user is performing a transaction with the application. As a result of swapping the copied key in the temporary memory of the infected device, the transferred cryptocurrencies will go not to the right recipient, but to the hacker’s wallet. Failure to take proper precautions, such as installing anti-virus software or even carefully checking the addresses to which you send crypto, can lead to the loss of digital assets.
So how do you protect cryptocurrencies? Certainly, the most effective practice is to use hardware wallets, which are specially designed devices responsible for storing private keys offline. Unfortunately, the vast majority of crypto-investors are quite careless about storing their funds and recklessly ignore the advantages of hardware wallets. They are used by a relatively small percentage of people, usually for a mundane reason – the purchase of the device involves an additional expense of more than one hundred Euros. And yet, cold wallets undeniably provide crypto-assets with the highest level of security, as they work by isolating private keys from Internet-connected devices, eliminating the risk of unauthorized access or theft to almost zero. Even when the device connects to a phone or computer online, the cryptographic keys assigned to your wallet remain out of the reach of hackers and viruses thanks to advanced storage technology on encrypted chips.
In addition, cold wallets largely eliminate the risk of the irreversible and fatal mistake of sending digital money to the wrong address. Each transfer of funds must be signed with the device before the crypto units leave the wallet. This gives you an additional chance to verify the transaction data – the wallet’s display shows the recipient’s public key, which you can easily and conveniently compare with the string of alphanumeric characters received from the addressee. Examples of popular hardware wallets include Ledger, Trezor and Keystone.
In addition to ignoring the benefits of cold wallets, cryptocurrency holders often neglect to protect their seed phrase and account login information on the exchange. “Never store a recovery phrase in electronic form and under no circumstances share it with anyone!” – this phrase may be a truism, but it is still worth quoting at this point. On the other hand, for exchange accounts, an effective practice to increase security will be the use of complex and unique passwords in combination with two-factor authentication (2FA). It involves entering one-time codes sent to the account owner by SMS or email each time he or she attempts to log in and execute a transaction to confirm it. Apropos of exchanges, one more fundamental rule: “An exchange user account is not a wallet, don’t keep large amounts of crypto on it for a long time!”. Why? We refer you to an earlier post on our blog.
Mistake 6 – Impulsive Action
We have already mentioned that in the process of investing, emotions are most often a bad advisor. Making decisions under the influence of strong emotions, such as an unbridled lust for success or a panicky fear of failure, is a common and deadly trap into which many cryptocurrency market participants fall. When logical analysis and a healthy distance from the situation step aside and emotions come to the fore, making a fateful move is almost certain. Fear of losing something important (FOMO, or Fear of Missing Out) syndrome, leading to irrational purchases, along with panic selling of assets are the most extreme forms of mental crisis an investor can fall into.
People suffering from FOMO syndrome tend to buy cryptocurrencies at inflated prices, usually during a period of surging rates. They are motivated by the fear of losing potential profits, as well as the fear of falling behind others. In most cases, this behavior results in a compulsive expensive purchase and an equally compulsive cheap resale, just after the price of the acquired assets enters a correction phase. The reason for the defeat of FOMO investors is poor nerves combined with a lack of patience; they fall into discouragement almost immediately after their portfolio loses value. An effective tool in the fight against this toxic pattern will be the development of a thoroughly thought-out investment strategy with clearly defined entry and exit points, and its consistent implementation, which will not be hindered by either media hype or the herd behavior of amateur investors off the street, acting in spite of the facts in blindness to the lust for easy money.
Another nagging affliction that works on a similar principle to FOMO is panic selling. It occurs when an investor unreflectively gets rid of accumulated resources in response to a sudden drop in prices or negative news in the media, driven by the fear of losing all of his capital. In this case impulsive decision-making prevents reaping the benefits of a potential market recovery, i.e. making up for the losses incurred. The remedy for misguided decisions dictated by fear may be to outline a long-term investment perspective, according to which volatility is viewed not as a frightening anomaly, but as a natural part of the peculiarities of the cryptocurrency market that can be exploited to generate profits. Focusing on the implementation of a concrete plan and common sense composure even during periods of significant economic downturn will help avoid making hasty decisions that can only be regretted later.
Mistake 7 – Ignorance of Regulations
An often-overlooked, but insanely important aspect of crypto investing is the need to stay abreast of laws regarding the taxation of profits from cryptocurrency trading. As the crypto market has grown significantly in recent years, many countries have updated tax policies or introduced entirely new regulatory frameworks to deal with the complexities of digital currencies. Beginning investors who neglect legal issues risk financial penalties from the tax office, which, as is well known, is an adversary that knows no mercy.
Understanding the tax implications of cryptocurrency transactions is undeniably essential, as many countries treat digital assets as taxable property. This means that capital gains or losses arise during the occasional buying and selling or regular trading of cryptocurrencies, and investors are required to report the balance of these transactions to local tax authorities. Failure to do so leads to fines and sometimes even criminal charges, depending on the jurisdiction. Regulations in different countries have specific nuances. For example, in the UK all possible forms of trading in digital currencies are taxed, not excluding swaps, i.e. direct exchanges of tokens for tokens, while in Poland the tax obligation arises only at the moment of exchanging crypto for zlotys, while the settlement is made under the rules of capital gains tax in the PIT-38 form.
Wanting to avoid the negative consequences of ignorance of the law, crypto holders should first thoroughly familiarize themselves with the country’s tax laws. It will also be useful to keep accurate records of cryptocurrency transactions and, if necessary, reach out to a professional tax advisor for advice. In this matter, a lot of useful information and practical tips can be found at Kryptoprawo.pl.
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