Crypto curious? 5 things every newbie investor should know
Odds are you’ve been hearing about crypto. Check out these key considerations before making your first purchase.
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Once relegated to a class of tech-savvy pioneers, cryptocurrency has gone mainstream in 2021. In February, Canadian regulators OK’d the first crypto exchange traded fund (ETF), and the acceptance and support of cryptocurrency has only grown in the months since.
But what is cryptocurrency, exactly? And what’s the difference between Bitcoin and other tokens? And is crypto taxed? These are good questions! Fair warning: crypto is complex. But this guide, sponsored by Canadian crypto platform Wealthsimple, will walk you through the fundamentals so you can feel confident when buying your first coin.
1. Bitcoin vs. altcoins
First, some basics: Cryptocurrency is a digital form of money that relies on a decentralized ledger—called blockchain—to record transactions. Blockchain is important to cryptocurrencies and decentralized finance because it allows participants to purchase goods and services without the need for an authoritative intermediary, like a bank, since the blockchain keeps track of how much money users have. The upside of this is that individuals retain far greater control of their money than they would if they stashed their cash in a traditional bank.
Cryptocurrencies are made up of coins and tokens. The two terms are not synonymous, despite them sometimes being used interchangeably. A coin refers to a native cryptocurrency built on its own blockchain. Examples of coins include Bitcoin, Ether and Litecoin. A token, on the other hand, is created on top of an existing blockchain. Most altcoins available today are tokens, built on top of existing blockchains, like Ethereum. It is important to note that when you purchase a coin or token, you are investing in the underlying blockchain. Often, prices of cryptocurrencies will change based on whether or not investors feel the underlying blockchain has value.
The concept of cryptocurrency was popularized by the pseudonymous and mysterious creator(s) of Bitcoin, Satoshi Nakamoto, in a 2008 whitepaper, in which he/they/it described a blockchain-based monetary system. This whitepaper and the introduction of Bitcoin the same year, inspired scores of companies to develop their own unique ledgers and create alternative cryptocurrencies. Nowadays, any coin or token that’s not Bitcoin is referred to as an altcoin. Some altcoins, like Ether, have become hugely popular in their own right. Ether is now the second largest cryptocurrency, after Bitcoin, in terms of market cap.
A principal component of the Bitcoin protocol deals with its supply. Bitcoin only allows for a total of 21 million coins to ever be created. This cap on the supply keeps Bitcoin’s scarcity in check. Nearly 19 million bitcoins have been created at the time of writing. The low number of circulating coins help bolster Bitcoin’s value.
Aside from total supply, altcoins can differ from Bitcoin in a number of ways. Ether, the native coin of the Ethereum blockchain, for example, was the first altcoin used to fuel transactions on a smart contract platform. Smart contracts, which are programs that execute automatically when specific conditions are met, allow for the creation of decentralized applications (dApps) on the Ethereum network. dApps can be used for a variety of purposes like gaming, finance, and social media.
One example of a popular dApp built on top of Ethereum is Uniswap. Uniswap is a decentralized exchange, allowing participants to quickly swap between the myriad of altcoins using Ethereum’s ERC-20 token standard. Uniswap’s token, UNI, is now listed in the top 20 cryptocurrencies by market cap.
Today, there are thousands of altcoins competing for the attention of consumers. And as blockchain technologies improve upon earlier iterations, new concepts, like decentralized finance (DeFi), are introduced to the masses.
2. DeFi can wait – Use a traditional trading platform for your first purchase
DeFi is an all-encompassing term referring to the addition of financial services to blockchain platforms. Without being permissioned by a central authority, DeFi allows for the global, peer-to-peer support of traditional banking features on cryptocurrency platforms. These features include interest, lending, derivatives and more.
Popularized during the summer of 2020, dApps allowing for financial services were built on top of blockchains like Ethereum. These DeFi applications allow consumers to swap tokens for reduced fees and even stake their assets for rewards.
The unregulated nature of DeFi, however, creates financial risks that traditional platforms have generally mitigated. As an example, larger entities are sometimes able to levy insider knowledge, creating disadvantages for smaller investors. And while DeFi has become popular with savvy consumers entrenched in the world of cryptocurrency, new entrants may want to wait a while before diving into the token swaps and liquidity pools that define this nascent market.
Based on a recent Finder survey, 1 in 10 adults in Canada own some form of cryptocurrency, with Bitcoin the most commonly-owned coin for Canadians. 52.9% of surveyed crypto owners own Bitcoin. The second most popular coin is Ethereum at 37.6%, with Dogecoin in third place at 24.7%.
Finding a trustworthy company to use for your initial purchase doesn’t have to be difficult. Wealthsimple has become a go-to platform for Canadians to invest in cryptocurrencies. Canada’s first regulated crypto platform, Wealthsimple offers more than 30 cryptocurrencies to its registered users — including Bitcoin, Ethereum, and Solana. Most importantly, Wealthsimple offers 24/7 customer support and top-notch security, with state-of-the-art coin coverage provided by Coincover.
But with so many cryptocurrencies available, how should you choose between them? Looking into the tokenomics of the ones you’re interested in can help guide your investment decision.
3. What are tokenomics?
Tokenomics describe the supply and demand of cryptocurrencies. By referencing the total and circulating supply of a given cryptocurrency, users can compare common metrics between coins that interest them.
The total supply refers to all coins or tokens that will ever be created by a specific blockchain protocol. In the case of Bitcoin, the process of creating coins comes through the computation of difficult algorithms necessary to secure transactions. This process is called mining. The newly minted coins are rewarded to miners for their effort.
The circulating supply reflects all of the coins or tokens that have been created to date. This metric is a key consideration used to determine the current valuation of a given cryptocurrency. The circulating supply, when multiplied by the price of a token, will reveal the current market cap. Using this calculation can give the user an idea of a token’s potential for future price gains.
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4. Storing your crypto
After making your purchase, you may want to move your tokens off of the platform you used to purchase them. To take true ownership of your assets, you will want to store your crypto in a cryptocurrency wallet.
A wallet is simply where you store your cryptocurrency assets. They can be custodial wallets, maintained by the platform you purchased your crypto on, or self-custody wallets. The difference lies in the control of your private keys.
Private keys are a string of letters and numbers that identify the owner of the stored assets, and encrypt the user’s wallet. As long as your private keys are kept safe, your funds are safely stored in your wallet. For this reason, it is important not to share your private keys with anyone.
While many different self-custody wallets are available, they can generally be separated into hardware and software varieties:
Hardware wallets are the most common method of storing cryptocurrencies. By keeping digital assets separated from easily compromised devices, like your smartphone, the offline or “cold” storage offered by hardware wallets gives their users true peace of mind. Importantly, hardware wallets store your private keys on the device itself. This safety feature prevents hackers from accessing your information through the internet.
Software wallets allow for connectivity and mobile access. Downloaded directly on your computer or smartphone, software wallets are intended for users wanting to utilize their assets online. Consumers use software wallets for purchasing goods and services, or accessing the dApps built on top of smart contract platforms.
5. How is cryptocurrency taxed in Canada?
One of the risks associated with cryptocurrency investing comes from improperly reporting them on your taxes. With regulatory measures rapidly changing, understanding the reporting requirements asked of you is vitally important.
The Canada Revenue Agency (CRA) treats cryptocurrency like a commodity. While income generated by crypto transactions should be reported as business or capital gains, losses from the same transactions should be similarly reported. When you hold more than one coin or token in a digital wallet, you will need to value each asset separately.
In Canada, simply possessing cryptocurrency is usually not taxable. However, selling or gifting your tokens can create tax consequences. Further, when trading one cryptocurrency for another, barter transaction rules apply. You will have to convert the value of your received cryptocurrency into Canadian dollars. Again, any increased value resulting from your trade will need to be reported as business or capital gains. It’s vital that participants keep records of each transaction for reporting purposes.
Is cryptocurrency investing safe? What are the risks?
At this point, cryptocurrencies are still speculative. No one knows which tokens or blockchains have long-term staying power and which will fade in time. Partially as a result, crypto prices tend to swing far more than stocks or other investments, so you want to avoid over-investing and finding yourself overexposed should crypto prices tumble. While volatility trading can be profitable for experienced strategists, the constant management of a crypto portfolio is often more work than beginning investors are ready to take on.
HODL — or “hold” — has become an investment strategy for many die-hard crypto traders who believe that buying and waiting promises better returns than trying to time trading to crypto price swings. According to this strategy, If you believe in a token’s potential, it’s best to let everyone else stress about price rollercoasters and instead commit for the long haul.
Crypto hacks are another important aspect of personal safety to consider. Despite the risk, there are a few ways to protect yourself from cyber attacks. Using a reputable exchange is a great way to keep your assets secure.
Hacks on cryptocurrency platforms occur when a company keeps a portion of their assets online – known as “hot” storage. If not stored properly, user accounts can also be left vulnerable to attack. Wealthsimple maintains a commercial criminal insurance policy against theft through their custodian, Gemini, Inc. Gemini, Inc. offers “cold” storage insurance coverage up to $200,000,000 across clients. It also protects users from potential security breaches, like hacks and cyber attacks. When using an online platform, make sure you take the time to understand the company’s security policies. Users should also enable two-factor authentication to secure their accounts from unauthorized access.
Investing in cryptocurrency is largely a personal decision. In the end, the choice to participate will depend on your own comfortability with the risks involved. Taking into account how the underlying blockchain technology derives value, tokenomics, tax implications, security considerations and financial risks will help you make a smart investment decision.