Bare-bones Cryptocurrency Investing Guide

Several lecturers and writers in the cryptocurrency space advise doing months and months of research before acquiring any cryptocurrency.  We present this under a different philosophy, that the best way to learn is by doing.  Also, we acknowledge human nature makes months of monk-like research while the price climbs higher somewhat unrealistic.  As such, here’s a bare-bones tutorial explaining how to get cryptocurrency by the safest and easiest path.  If you are a true beginner to the space, welcome, and take your first position with only as much money as you are willing to lose.  As you learn more, you will be able to safely invest more.

Getting Started in Cryptocurrency Investing

Let’s start with the disclaimers: 1) The space evolves very rapidly, better practices, hardware, and exchanges are constantly emerging. 2) This is written to orient you to the tools and resources to trade and invest, not the underlying technology or investing thesis. 3) These are not explicit recommendations to trade and invest in or through anything.  As always, you are responsible for your own financial decisions and due diligence.  Specifically, all of the services and vendors mentioned are third parties.

Whew. With that out of the way, let’s get started.

Cryptocurrency basics

First we need to know what it means to “own” some cryptocurrency. Cryptocurrencies are based on the idea of a blockchain, which is a public, decentralized, ledger. The blockchain ledger keeps the accounting of how much cryptocurrency each address controls. If you want cryptocurrency, therefore, you need an address and then you need someone else to send cryptocurrency to that address. As the blockchain grows with linked blocks of new transactions, the credit to your address becomes sealed by an increasingly-difficult-to-fake set of computations, like a fly in amber. When you spend your cryptocurrency, you need to inform the blockchain of the transaction – specifically, the address you want to send it to and the amount that you want to send.
Simplified blockchain diagram from: Preethi Kasireddy’s tutorial http://bit.ly/2tKMeIu

Because the blockchain is a public ledger, there needs to be a mechanism to ensure that you are the only one who can transact on your behalf. This works through some amazing mathematical ideas worked out in the 1970’s called “public key cryptography.” Public key cryptography creates an un-forge-able digital signature of sorts by having a pair of keys; a public key that is distributed to anyone who needs to verify your authorized transactions, and a private key that you use to digitally sign the transactions. Think of them like two puzzle pieces, you can distribute one of the puzzle pieces (public key) and you can demonstrate that the two pieces fit together, but you don’t have to show the private puzzle piece. The basic security consideration of cryptocurrencies, therefore, is that if someone knows your private key, they can make transactions on your behalf.

In summary, to get cryptocurrency you need an address and you need to have someone send cryptocurrency to that address. In order to make transactions, you need to have your private keys. In order to make sure you’re the only making these transactions, you need to keep your private keys secure.

How do you get an address?

There are a few possibilities. The traditional way to do this is to download and install a software wallet. The new software wallet syncs up to the blockchain and verifies the amount of cryptocurrency in that address. As new blocks are added to the blockchain, the amount is updated to reflect any transactions to or from your new address. Making transactions through a software wallet is much easier than currency transfers through the traditional banking system, which is a great part of the appeal of cryptocurrencies.

Security note: The best idea is to download a cryptocurrency’s “official” software wallet from their official website.  In any case, you must do due diligence on the wallet itself.  Is it open source?  How long has it been used?  Has the software team ever released anything with an exploit?

For instance, official bitcoin wallets and a good discussion of wallet security can be found on their website:

https://bitcoin.org/en/choose-your-wallet

Hardware and paper wallets

You can purchase a hardware wallet, which is a specialized device (basically, a glorified USB drive) that functions like a software wallet, but is secure against the computer with the software wallet getting compromised.

Security note: Saving a few dollars is absolutely not worth the risk of buying a used hardware wallet. Hardware wallets should be purchased directly through the manufacturer, licensed dealers, or a major retailer.  If you’re buying one through Amazon, are you buying it from Amazon, or a third-party seller?  The wallet should come with intact security seals on the box.

The two most popular hardware wallets are linked below.  Make sure they support the cryptocurrency you wish to store on them.

Trezor: https://trezor.io/

Ledger Nano S: https://www.ledgerwallet.com/products/ledger-nano-s

You can also create a paper wallet, which essentially is a piece of paper that has your address, private, and public keys (usually the address and public keys are the same, but this doesn’t need to be true). The upside here is that you are concealing your private keys the same way you conceal any physical object.

https://www.coindesk.com/information/paper-wallet-tutorial/

Exchange wallets

More common these days is to use a custodial service, usually an exchange, that maintains your address and holds your private keys for you. This makes it easy to trade, but again, you’re trusting someone to perform the most essential security function of cryptocurrency for you (that is, keeping the private keys safe). Some exchanges offer “cold storage” for certain cryptocurrencies. Cryptocurrency cold storage is the practice of keeping private keys off-line, for example on a computer that is not connected to the internet so that it cannot be attacked remotely. If you do chose to keep funds on exchanges, cold storage is the safest method.

You should choose among these based on your philosophy of use. If you’re an active trader, you’d keep funds on the exchange, giving a lot of security in order to move in between currencies quickly. If you want to invest in a particular currency and hodl over a long time horizon while sleeping soundly, the best solution is a hardware wallet or your own cold-storage solution.

How do you get someone to send cryptocurrency to that address?

You have picked a wallet based on your investing/trading style,  great.  Now you need to get cryptocurrency assigned to it.  Again, there are a multiplicity of ways to do this, you could accept payments for goods or services in cryptocurrency, buy it for fiat currency directly on an exchange, or try mining.  We’ll skip mining because, if you’re prepared to acquire a significant amount of crypto through a mining operation, hopefully you know all this.

Merchant payments

If you want to accept payments in cryptocurrency, you simply have to give the other party your address and wait for the funds to show up in your wallet. Reminder that you should be 100% certain that you’re distributing your address and never your private key. Several exchanges, like Coinbase, even have widgets for putting a bitcoin payment option in your website. If you do this, of course, you’ll need to be mindful of the volatility in the local currency/cryptocurrency exchange rate.

This is a good small business FAQ on merchant payments:
https://en.bitcoin.it/wiki/How_to_accept_Bitcoin,_for_small_businesses

Crytpocurrency Exchanges

Most commonly, cryptocurrencies are purchased with fiat (sovereign) currency on exchanges which are made expressly for this purpose. In order to do this, you need to make an account on the exchange. Typically, this is about as complex as opening a new bank account. The process should comply with any applicable local laws for money transmitters, so they’ll need to know information about your residency status and might require forms of government ID. Once you have an exchange account, you’ll need to fund it with fiat currency. As a reminder of one of the reasons cryptocurrencies exist in the first place, this usually will be through an ACH transfer from your bank and will take days. The entire process might take over a week as this is where the slow bumpy onramp of the traditional banking system merges with the superhighway of digital currencies.

Once the ACH handshake has completed, you can now purchase cryptocurrency. Exchanges will let you buy cryptocurrency directly, usually taking 1% or more commission. A good exchange will lock in the fiat/crypto exchange rate at the time of purchase even if the crypto isn’t credited to your account until the bank transfer completes (possibly a week or more).

Alternatively, you can simply transfer funds to your exchange account and use the associated exchange directly. The exchanges have the same sort of order types as a stock brokerage account; market buy and sell, limit orders, and stops. Some exchanges have commissions on all trades, but usually the fees are lower or even waived for orders which are not instantly filled. This “maker/taker” fee structure promotes liquidity in the exchange. More on this later. Each exchange is different, but if you can use a Charles Schwab account, you can navigate the exchange’s order book and types. By doing this, you’ll not only dodge some fees, but see some of the important mechanics of how exchanges function.  The possible downside is that if you transfer funds to buy cryptocurrencies on the exchange directly, you will not be locked into a price at the time of transferring funds.

An example to get started

Here we’ll walk through the entire procedure which will cover the most common use case. Let’s say you’re curious about bitcoin and want to tuck away $1500 worth of it to see what happens in the next few years.

We’ll use Coinbase/GDAX as the exchange since their insurance policy is the most robust and they have gone through the compliance to operate in all 50 US states.  Coinbase/GDAX only supports the cryptocurrencies Bitcoin, Litecoin, and Ethereum.  If you want something else, you generally need to buy bitcoin and exchange the bitcoin for the other cryptocurrency on a different exchange that does support it.

Investing note: The exchanges aren’t doing research for you, they list coins based on transaction volume (therefore exchange fees), not because the coin is a good investment.  Some large exchanges list coins which are obvious scams but trade heavily.

First make sure you’re comfortable with Coinbase’s privacy and insurance policies. Your due diligence should match your level of investment.  For any exchange or cryptocurrency business, some key questions to look into are:

  • Has the exchange ever been hacked?
  • How is the exchange insured?
  • Is the exchange under any legal investigations?
  • Where is the exchange domiciled?
  • Does the exchange regularly undergo “proof of reserves” audits?

Security note: There have been some extremely insidious phishing attempts using urls that look very close to reputable cryptocurrency services. They have even purchased Google ad banners, make 100% sure you’re navigating to the website you actually want.

As such, here’s a referral link to Coinbase that should have my name in it:  https://www.coinbase.com/join/5754a6c66586f2007b00065c

The exchange run by Coinbase is called GDAX. As of the time of writing this, you’ll need to provide government ID to use GDAX and the facial recognition software is rather conservative and finicky (a good thing). I’ve known people who have tried for an hour to get it to work w/o success. The Coinbase app seems to work better for that specific purpose.

Once you’re set up and have a linked bank account, you can choose to buy cryptocurrencies directly through Coinbase, or to transfer the money to Coinbase and then (instantly) move it to the GDAX exchange to trade directly. If you do the former, you could average in by buying a few $300 lots if you wanted to spread out the risk of being the last purchaser before a sharp correction.

If you use the GDAX exchange directly, you must log in, transfer the money from Coinbase and then enter the order. In the screenshot below, there’s an example of how to set a limit order which will incur no fees and most likely be filled very quickly. There is the possibility that the price will walk away from your order, but the intraday volatility of most markets make it highly likely to be filled if it’s within 0.1% of the market price.  Make sure your order is filled, of course.
An example GDAX limit order. “Look ma, no fees!”
One way or another you have some cryptocurrency, congratulations! Now you need to store it in the way that’s most in line with your philosophy of use. In this example, we’re assuming you’re a long term hodler (“holder,” you’ll figure it out…). You can use Coinbase’s cold-storage. In this case, you might have to transfer funds from GDAX to Coinbase. Alternatively, you can take the cryptocurrency entirely off of the exchange by sending it from your Coinbase account to either a hardware wallet which has its own address. This transaction will update the blockchain and require fees, paid to the computers that validate and cryptographically seal the blocks of transactions into the ledger.

You’ll need to refer to the specific setup steps for whatever hardware wallet you purchase before the transfer.

Security note: Pay careful attention to your hardware wallet’s recovery seed – what it is and how important keeping it safe is.

Practice safe transacting

The security and immutability of the blockchain cuts both ways. If you mess up a transaction, there is no going back. Probably the most common mistake, especially with the huge proliferation of currencies, is to send things to the wrong address. Because of the huge target space of addresses, doing this is effectively like putting a stack of bills into a fireplace – they’re lost to everyone …forever.
  1. Verify that the cryptocurrencies match. Seems obvious, but it’s more and more difficult with the misleading names and the exchanges that host dozens of cryptocurrencies. You cannot send Ethereum to an Ethereum Classic address. You cannot send Bitcoin to a Bitcoin Cash address. Barring a statistical miracle, effect is to “burn” the cryptocurrency.
  2. Triple-check the address you’re sending cryptocurrencies to. Verify that the first and last few digits match after you enter the recipient address, so that you’re sure nothing was cut off or changed.
  3. For large transfers, do it in lots. Send a small amount to the address. Wait for the transaction to go through, then make a bigger transaction once you’ve verified that it worked.
 
At the end of this, you should have a hardware wallet which can be tucked in a firesafe while you peek at the price of your cryptocurrency, or even verify the amount in your addresses on the blockchains itself without ever touching the wallet.  You will have also successfully used all of the parts of the cryptocurrency ecosystem and are well on your way to being able to invest successfully.
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