As cryptocurrencies (cryptos) have moved more and more into mainstream investing/trading, Chicago Partners has received numerous inquiries about them. While we cannot currently invest in them directly for you, this article should help you to gain some understanding about what cryptos are, how you can purchase them, and where you can store them.

We’ll keep this as general as possible (there are many differences between specific cryptocurrencies), while still touching all of the important main topics. It should be noted that examples used within this article are not endorsements of such products or cryptocurrencies by Chicago Partners Wealth Advisors.

Where it came from

The idea of digital currency has been around since 1983, but the first decentralized cryptocurrency, Bitcoin, did not appear until 2009. Bitcoin was created by developer Satoshi Nakamoto, which is a pseudonym. It is still unconfirmed who he actually is. Since then, many other cryptos have been created and are currently traded and used.

How it works

Most cryptos are on decentralized networks. This means that no one central authority holds the historical information on or transacts the crypto. Instead, there are usually many large “nodes” that keep track of all the transfer and account history information on what is called a “blockchain.”

There are also smaller members of the network that are constantly verifying transactions and posting them to the nodes so the transaction can be recorded to the blockchain. In this way, the network history is copied to many systems, therefore not allowing any one person or group to manipulate the market or bring it down if the node fails.

Each holder of cryptocurrency has what is called a “wallet,” which is simply a pair of addresses. One is private and one is public. A user can use their wallet’s private address to send crypto to a public address. The value these wallets hold are stored on the blockchain.

Current uses

Adoption of cryptocurrencies as an alternative to traditional currencies is growing. Many people, however, are using cryptos as a store of value.

Exchanges

Exchanges can be used to purchase cryptocurrencies with fiat currencies, the reverse, or to trade one crypto for another. For each crypto that you own, the exchange will create an on-exchange wallet to hold that crypto. You can either leave the crypto in that wallet or move it to a different wallet.

Coinbase

One of the most common exchanges that retail investors are using to buy cryptocurrencies is Coinbase. It is a fairly straightforward exchange to use, especially when compared to some of the more advanced exchanges with complicated functions. Coinbase is based in San Francisco which, makes it a little more inclined to cooperate with U.S. laws.

Coinbase alternatives

Some other alternatives to Coinbase are Gemini, the exchange founded by the Winklevoss twins, and Kraken, which is available in most U.S. states. Careful research should be done when choosing an exchange. Things to check include, but are not limited to, regulations regarding U.S.-based traders, fees, withdrawal limits, and security.

Wallets

As mentioned above, you will have a wallet for each cryptocurrency that you purchase on an exchange, but you also have the option of transferring your crypto to a different wallet. These wallets can vary greatly in form and features.

The first type of wallet, which includes those on exchanges, is a “hot wallet.” A hot wallet is a wallet that is connected to the internet. These allow for greater flexibility in sending, receiving, buying, and selling your crypto, but also are more vulnerable to hacking. There will be varying levels of quality in security systems between wallets, so it is important to do some research before choosing which hot wallet you want to use, if any. Some examples of commonly used hot wallets are Exodus, which includes a built-in exchange for crypto-to-crypto trades, and Electrum, which is one of the older wallets and is thought to have fairly good security for a hot wallet.

The second type of wallet, which is more secure, is a cold wallet. These are not connected to the internet. They will often connect to your computer using USB or possibly Bluetooth (less secure than USB) and are more suited to a long-term buy-and-hold strategy. For most people, these will have a steeper learning curve, but if you hold large amounts of cryptocurrency, the added security could be worth it. The most commonly used cold wallets include those made by Ledger and Trezor, which both offer several models.

Keeping your passwords and seed phrases safe

When creating a wallet, you will be required to make a password and will often receive a seed phrase, which is a list of words that can be used to recover your funds if something happens to your wallet or password. These are both very important to keep safe. If they fall into the wrong hands, your crypto could be stolen. If you forget them, your crypto could be lost (See Stefan Thomas).

We recommend writing down both your password and your seed phrase, and keeping them in a secure location like a safe or a lockbox. You could also store them on a USB drive that you keep in a secret location. You should also make sure that a trusted person, or people, know about your crypto and how they can access it if something were to happen to you.

Just as any other security can be suitable for some investor and not for others, the same is true for crypto. Many cryptocurrencies seem to have low correlations with other asset classes, which make some attractive opportunities for diversification, but as the novelty wears off over time, this could change. Each crypto, however, should be examined to obtain its unique risk/return profile because there can be much variation between cryptos as well.

Some cryptos also afford their holders the opportunity to “stake” them in some wallets. Staking some cryptocurrencies will earn “interest” on the staked portion, which can serve as an income-generating activity. Many of these currencies will, however, have wildly fluctuating APRs.

None of the following constitutes a recommendation or endorsement of specific cryptocurrencies.

Today, almost everyone has heard of Bitcoin, and many know of Ethereum and Litecoin, but there are actually thousands of other coins. Most of these coins have varying features including security/anonymity levels, use cases, speed of transaction, maximum circulation levels, and new-coin/token minting methods.

Some of the most popular in the crypto-sphere, but less familiar in the mainstream, include the following:

• Tether: This crypto is pegged to the US Dollar
• Polkadot: Very popular for staking
• Cardano: Aims to grow scientific innovation
• Bitcoin Cash: A fork of Bitcoin (based on Bitcoin) that seeks to make it more usable for everyday transactions.
• Monero: Focused on privacy

As cryptocurrency becomes more widely adopted, it will undoubtedly become a larger portion of investment portfolios. As with any investment vehicle, it requires careful consideration and research. Before purchasing, one foundational strategy you can take to set your cryptocurrency investments up for success is to understand the basics of what you are buying and the effect it will have on your overall portfolio’s risk/return profile. If you do decide to purchase, take precautions to make sure your investment is not stolen or lost. Be sure to save your passwords and seed phrases somewhere safe.