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How not to invest in cryptocurrency

Reading time: 13 minutes

At Sorted, we’re keen to see you getting ahead financially and growing your money for the long term. Now generally, cryptocurrency – digital money that relies on complex computer code to be secure – is not a way to do that.

Buying and selling cryptocurrency such as Bitcoin (the first cryptocurrency to take off) is more often not investing, but more like speculation and gambling. You take a punt and hope that someone else one day will buy your coins and pay more than you did. More on that below.

It’s a wild west in the world of crypto, with entirely new digital economies that have sprung up like mushrooms. Hold on as we walk you through the basics and aim to keep you (and your cash) safe.

In this guide

What is cryptocurrency?

Buying cryptocurrency is not investing

How cryptocurrency works

Prices for cryptocurrency swing wildly

Cryptocurrency is too often a scam

How to stay safe if you’re buying crypto

Cryptocurrency FAQs

How not to invest in cryptocurrency

It’s a wild west in the world of crypto, with entirely new digital economies that have sprung up like mushrooms. Hold on as we walk you through the basics and aim to keep you (and your cash) safe.

What is cryptocurrency?

If you’re new to the crypto world, and especially if your friends are encouraging you not to miss out, here are the key things to understand.

Cryptocurrency

Blockchain

Crypto wallets

Crypto exchanges

Non-fungible tokens (NFTs)

Cryptocurrency

Virtual money that can be exchanged and hold value just like real-world dollars.

‘Crypto’ is short for cryptography – encryption is used to secure and verify transactions, protect your privacy, prevent fraud and control how many coins there are.

Cryptocurrencies are not controlled by any central bank or government. Each one is handled within a network that lets people exchange and transact directly with each other. To do this, it relies on blockchain technology.

Blockchain

A secure ‘chain’ of digital ‘blocks’ shared across a wide network of computers.

Blockchains keep a trusted digital record of all cryptocurrency bought and sold. The computers independently verify the transactions recorded, which prevents coins from being spent more than once, or a single coin being held by more than one person at a time.

A blockchain is an unchangeable, transparent record, although users are anonymous and only identified by their user names.

Crypto wallets

Software programs or hardware devices that allow you to securely store your cryptocurrencies, as well as send and receive them.

‘Hot’ wallets are online and connected to the internet, which makes it easy to get to your crypto and trade. But they’re less secure than ‘cold’ wallets, which are more like a digital safe – they’re offline and more secure, but they’re harder for you to get to as well.

Crypto exchanges

Digital platforms where buyers and sellers of cryptocurrency set their prices and trade.

When buyers wanting a cryptocurrency accept higher offers, it causes the price of a cryptocurrency to rise. When buyers aren’t willing to pay as much, the price falls, making the coins worth less.

Non-fungible tokens (NFTs)

Unique digital tokens that can’t be copied. That means they can’t be replicated, and that’s what gives them their perceived value. (Well, that and the celebrity hype.) They’re digital items like sports collectibles, art, land or even virtual trees that users buy and sell online.

NFTs can also represent real-world stuff like property or art, even. If you buy the NFT, the art is yours. (Hopefully!) But note that word ‘represent’. NFTs are often not the thing itself – they are often just a link to it.

The actual asset the NFT represents – even if it’s a digital piece of art like a photo – is often not stored on the blockchain. It’s typically too big, and therefore too expensive to actually be on the chain. This means it’s hosted somewhere else (often on a centralised server).

Which is why when you buy an NFT, you may really only be getting the link to the item – a treasure map instead of the treasure itself.

Buying cryptocurrency is not investing

Many things get called ‘investments’ or ‘assets’ these days – but are they really? A true investment asset worth owning is not just anything you can sell, it needs to eventually put more money back into your pocket. Investing in assets is supposed to be about growing our money for the future.

In the virtual economy of cryptocurrency and NFTs, it’s hard to tell what really is an asset that will grow in value. Predicting their future value is extremely difficult – it’s been more influenced by celebrity and hype at times than anything else.

If you are taking a punt on NFTs or crypto in the hope that someone else will pay more for them in the future, you are not investing – you’re speculating. (For more on the difference, see our investing guide.)

Speculating is more like gaming or gambling, so it’s important to only put in money you are prepared to play and lose. And if it’s gambling, it should be entertaining and fun – not risking any hard-earned savings you need back for your future!

When is an investment not an investment?

Watch out for things calling themselves ‘investments’ – they might not be. The really good ones ‘produce’ something such as interest, rent or dividends from profits. Based on those estimated future earnings, they have value now and can grow in value as well. Sometimes we fool ourselves by justifying buying something we want as an ‘investment’, but it really won’t end up returning us any money at all.

How cryptocurrency works

Cryptocurrency uses cryptography to secure and verify transactions, and to control how new coins are created. Since it operates independently of a central bank or government, it is not controlled by any single entity (you’ll often hear it called ‘decentralised’).

When you want to trade or pay with a cryptocurrency, you’re basically sending a request to the network of computers that maintain the cryptocurrency’s blockchain. The request contains information about the transaction, such as the amount and your address. The information is then verified by the network, which uses complex algorithms to ensure that the transaction is right and that you have the necessary funds.

Once the transaction is verified, it is added to a block of other transactions, which is then added to the blockchain. This creates a permanent, unalterable record of the transaction that is visible to everyone on the network.

To keep the network running, cryptocurrency systems often offer rewards to people who successfully add a block to the blockchain by validating and processing transactions. These rewards are typically newly created cryptocurrency coins. This is what Bitcoin ‘miners’, for example, are doing – supporting the network and receiving new Bitcoin in return.

The lure of cryptocurrency is that it is a secure and decentralised way to transact without the need for a central authority. But it still relies on a certain amount of trust, and crypto exchanges, for example, have tended to become centralised anyway.

The short of it is: do as much research as possible before you buy into this virtual economy.

Also, it’s important to know that the crypto economy has real-world tax implications when you buy and sell. For more, see Inland Revenue’s website.

Prices for cryptocurrency swing wildly

Cryptocurrencies are high risk and highly volatile – their price can spike or fall off a cliff very quickly. Most coins unfortunately become worthless sooner or later.

So far, the price of the more established cryptocurrencies, such as Bitcoin or Ethereum, has tended to swing wildly in line with other risky investments such as shares. So if the sharemarket is falling and you’re looking to avoid losing money by owning cryptocurrency instead, it probably won’t work.

If you’re feeling FOMO about everyone else making money in the crypto world, know that hype influences the perceived value of crypto coins and NFTs. Celebrities and influencers are able to affect how much cryptocurrency or NFTs are worth, so they are quite active in this space.

Unfortunately, markets can be manipulated in order to give the impression of success, pump up the price of cryptocurrency or earn rewards.

Cryptocurrency is too often a scam

The virtual economy is a high-risk, unregulated space. Scams are rampant.

Cryptocurrencies, crypto exchanges and the people who use them are often the targets of hacking, online fraud and scams. Exchanges are targeted by aggressive, sophisticated cyber-attacks – attracted by the larg ometimes even collusion (cooperating secretly to defraud people).

Remember, if something seems too good to be true, it’s probably fraud. And the moment you send your money overseas, you lose any leverage to get it back.

How to stay safe if you’re buying crypto

Happily, there are a number of ways to keep your money relatively safe while handling cryptocurrency, including the following.

Before you buy, look into whether you can get your money out. It may be more difficult than you think.

Getting your money out of your virtual investments depends on other people being ready to buy. So even if what you own is valuable, it may be difficult to find a buyer.
Even the most rare and precious NFTs in the world (‘1/1s’) may not be liquid, which means you may own one, but you may not find buyers. This locks up your money.

If you are purchasing cryptocurrencies, choose a New Zealand-based trading platform.

These must be on the Financial Service Providers Register and belong to a dispute resolution service – which can offer you some protection in case things go pear-shaped.
If you use offshore service providers to trade in crypto assets, you increase your risks, and remove any protection you might have from using a New Zealand-based provider.

Protect your investment information, your wallet and encryption keys.
Consider using a cold wallet for your cryptocurrency to keep it safe.

Avoid sending your cryptocurrency overseas to anyone you’ve never met in person.
With New Zealanders being targeted by fraudsters daily, the odds of you receiving a request that is a scam are insanely high.

How do I buy and sell crypto?

In New Zealand, you can buy and sell cryptocurrency through exchanges such as Easy Crypto or Swyftx. Essentially you create an account, deposit your real money, place an order to buy or sell, and store your cryptocurrency in a digital wallet. You can store it in a ‘hot’ wallet provided by the exchange or use a separate hardware or software ‘cold’ wallet for more security. You would use the same exchange to sell your crypto, either for other virtual coins or for dollars.

How do I invest in crypto?

Um, you don’t. Well, not in the true sense of investing, anyhow. The idea when you invest is to buy assets that can ‘return’ money to you, thanks to the future income they produce. For example, you buy shares in companies that make profits, which then pay dividends back to shareholders. Cryptocurrency, since it typically has no future income to measure, is essentially a punt – it’s speculation and not investing. Which makes it more like gaming, gambling or… guessing. Guessing whether it will go up in value or not, and whether there will be someone else down the line to pay more for it when you want to sell your coins.

What are different types of crypto?

Coins and tokens are two types of crypto. Bitcoin, the first cryptocurrency to take off, is a typical example of a coin, and most of the cryptocurrencies we think of are coins. But there are also tokens, like NFTs, which can represent another asset such as a piece of art or even property.

Altcoins are different from Bitcoin, which was originally intended mostly as a currency to buy things with. While these altcoins can be bought and sold like any coin, they are made to do many other things instead. An altcoin example is Ethereum, which lets users run applications on its blockchain and host smart contracts.

Stablecoins are cryptocurrencies whose value is tied to the value of another asset, such as the US dollar. If functioning correctly, one stablecoin pegged to the US dollar should always be worth $1, for instance. (But they don’t always function as intended.)

What is an NFT?

This is a good question, because it’s not always clear what you’re buying when you purchase a non-fungible token or NFT. ‘Non-fungible’ means this digital token can’t be exchanged for another (unlike a coin, which can be switched with another of equal value without worry). They’re unique and can’t be replicated. NFTs are bought and sold, and can represent either digital stuff – like a digital design or a video – or real-world stuff – like a painting itself. If you buy the NFT, the art is yours. (Hopefully!) Their value is often based on celebrity hype.

Is crypto safe? Is it secure?

The security of cryptocurrencies is based both on the cryptography, which keeps a coin from being copied or spent over and over, and on the underlying blockchain technology, which automatically keeps an unchangeable record that can be verified by a network of computers.

Not having to trust a single entity, like a bank, to keep track of everything and get it right seems to offer more security. However, there are still big players in this space, particularly the cryptocurrency exchanges, which unfortunately have repeatedly been targets of fraudsters – both from outside and inside the exchanges themselves.

And because these crypto-economies are so new, there are too many ways to lose your money which have not yet been plugged by regulations and laws. You’ll want to take steps to make sure your money and coins are secure. Stay safe out there!

What are the big risks that come with crypto?

Here are our top 10 risks when it comes to cryptocurrency:

The value of your cryptocurrency suddenly falls steeply – or is wiped out completely.
Your cryptocurrency, if not stored properly, gets stolen by a hack, theft or scam.
You gear up and borrow money to buy cryptocurrency, but when the price falls, you are left on the hook and need to pay back much more money than anticipated.
The government changes the rules, which affects the value of your cryptocurrency. Or it bans it outright.
The technology is still in early stage and may contain coding mistakes or weak networks that can be hacked.
You have little legal protection in this unregulated space from hacks, disputes or investment scams.
The price of your cryptocurrency is affected by market factors, such as how other investors feel about crypto, supply and demand, the economy, and generally what’s going on in the world politically.
The exchange you trade on can be hacked, experience other technical challenges, or even go out of business.
Especially when the price of cryptocurrencies is swinging wildly, it may be difficult for you to sell your cryptocurrency in a hurry to someone else. This means your money in crypto is pretty much locked up, unfortunately.
The value of your cryptocurrency tanks for other unforeseen reasons. There’s really not much underpinning the value of many cryptocurrencies and tokens. People are speculating that they will continue to be worth something, which is okay… until they aren’t worth anything.

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How not to invest in cryptocurrency

Reading time: 13 minutes

In this guide

How not to invest in cryptocurrency

What is cryptocurrency?

Cryptocurrency

Blockchain

Crypto wallets

Crypto exchanges

Non-fungible tokens (NFTs)

Cryptocurrency

Blockchain

Crypto wallets

Crypto exchanges

Non-fungible tokens (NFTs)

Buying cryptocurrency is not investing

When is an investment not an investment?

How cryptocurrency works

Prices for cryptocurrency swing wildly

Cryptocurrency is too often a scam

How to stay safe if you’re buying crypto

Happily, there are a number of ways to keep your money relatively safe while handling cryptocurrency, including the following.

Cryptocurrency FAQs

How do I buy and sell crypto?

How do I invest in crypto?

What are different types of crypto?

What is an NFT?

Is crypto safe? Is it secure?

What are the big risks that come with crypto?

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