I wrote this essay because there aren’t many thorough and reliable guides on how to buy bitcoin. A bitcoin investor since 2013, I’ve rode the price up and down…and up and down…and now mostly up. I’ve bought bitcoin through exchanges and buying services. I’ve earned bitcoin by lending it out. I’ve spent it and given it as a wedding gift. And in those four years I’ve consumed everything I could get my hands on – whitepapers, essays, panel discussions, podcasts. Now I’ll try to share the useful bits with you.
In this essay we’ll go over why an individual investor should buy bitcoin and how to do it responsibly and securely:
- Who is the intended audience?
- What are my credentials?
- Why should you invest in bitcoin?
- What are bitcoin’s risks?
- How do you actually buy it?
- What are some advanced ways to gain investment exposure?
- Additional related reading
Who is this buying guide intended for?
The target reader is an individual investor who wants to put a few thousand dollars into bitcoin as a long-term, buy-and-hold investment opportunity. Long-term means at least 2-3 years. Buy and hold means NOT trying to time the markets but instead either buying all of them at one time or dollar cost averaging over an extended period.
For an individual investor, your bitcoin investment should only be a small percentage of your cash and cash-like assets, perhaps 2-3%, and not more than 5-10%. Yes, I’ve invested more than that, but this is one of those scenarios where I’ll recommend that you do what I say, not what I do. Why? Because Bitcoin is young, it is a comparably volatile asset, and there are a lot of unknowns. Your investment could fall 50% in a few months and take years to recover as it has done several times already. Daily 5-10% price swings are not uncommon.
My reader will have some knowledge of money management and financial investing. They should already own an investment portfolio. They’ve purchased stocks and bonds and mutual funds. They may own complex products like real estate and know how to trade derivatives. I assume this because there is an ocean of good investing information out there and my goal is to add some value. So I won’t, for example, explain concepts like dollar-cost averaging and opportunity costs and financial leverage.
If you’re looking to buy $10K or more of bitcoin, this guide won’t be as useful for you. At a certain dollar amount, somewhere in the range of $10,000 to $100,000 USD, your safest and smartest option is to buy bitcoin directly through specialized services that go by many names, among them bitcoin brokers, dark pools, and over-the-counter (OTC). Not only will they get you a better price than standard bitcoin buying services, but they often offer storage services as well.
What are my credentials?
I graduated Stanford in 2006 and have since worked at McKinsey and Google and started several tech companies. Most of them failed. I graduated Y Combinator with a publishing startup and raised $1M from great investors. Ultimately we couldn’t scale the business. I was on the founding team of another startup, shopkick, that was acquired by SK Telecom for $200M.
As for bitcoin, I have invested personally since 2013 and have also bought altcoins such as ethereum and dogecoin. I am now learning about blockchain tokens and ICOs (initial coin offerings) and expect to participate in those as well. I am still skeptical about the latter, but it’s in my interests to understand it thoroughly. It’s a world of fascinating innovation. I read and watch just about everything tangentially related to cryptocurrencies and blockchain, from white papers to podcasts to YouTube lectures, take notes on all of it, and want to share that knowledge with you.
Why should you buy bitcoin?
Since May 2010 when Laszlo Hanyecz persuaded someone to order him two large pizzas in return for 10,000 bitcoins, setting the price of a bitcoin at one quarter of a penny, bitcoin has appreciated by 360,000x (that is not a typo) to nearly $1000 at the end of 2016. If we consider bitcoin a currency – a function it performs among many others – it would have been the best performing currency in 2010, 2011, 2012, and 2013, the worst performing one in 2014, and the best one again in 2015 and 2016. Buckle up.
To give you a concrete and small sense of its performance, if you put $1 in at the beginning of each year and sold it on December 31st of that year:
$1 bitcoin in 2011 would become $14 at the end of the year.
$1 in 2012 would become $2.58.
$1 in 2013 would become $57.51 (again, not a typo!).
$1 in 2014 would become $0.38 (its one losing year).
$1 in 2015 would become $1.35.
$1 in 2016 would become $2.20.
You’d have made money every year – and usually a lot of it – except for 2014.
And today, I’m more confident than ever that what bitcoin represents – a class of math and cryptography-backed currencies, an innovation called the blockchain, and a community of hackers and entrepreneurs hoping to reshape money – is one of the best investment opportunities you can make in the next 10 years. If you can simply buy the right coins, and store them safely, and wait patiently, I’m almost certain your investment will pay off. Just don’t mortgage your house to do it!
Bitcoin investing carries many risks. We’ll talk about all of them in somewhat excruciating detail in later essays. But even with these risks, your average investor would be remiss – indeed even irresponsible – to not invest at least SOME of their money in this asset class.
Your investment could be $100. It could be $2 million. If you’re going to invest, plan to hold your bitcoin for AT LEAST 2-3 years. The speculative nature of cryptocurrency and its comparatively small trading volume means it is subject to wild price swings day and night. It’s a true 24/7 global market and it moves at the speed of math and data.
While its fundamentals consistently improve, the price may not reflect this reality for a long time. Investors are not always rational and we shouldn’t expect them to be. In my view, 2-3 years is a long enough period to smooth out the uncertainty and prevent you from making poor decisions based on emotion and a desire to time the market.
I expect to hold onto my bitcoin well into the 2020s. Now, that doesn’t mean I’m not re-evaluating my position every day. And it doesn’t mean I won’t sell some of my position or invest more money along the way, into bitcoin or altcoins or other related digital assets. It just means I have a very long-term view of my core holdings and will do whatever I can to help this future come to fruition.
What are bitcoin’s biggest risks?
Every great investment carries great risk. Like CV White says, success is the accomplishment of that which most people think can’t be done.
There is a nonzero chance you could lose your investment. This should be stated over and over until you’ve internalized the reality. But we will do our best to minimize every controllable risk, from buying to storing to selling to diversifying into altcoins to investing in ICOs to gaining yield through services like bitcoin lending. And much more.
For now, I will name just a few of the major concerns about bitcoin as an investment opportunity:
- Bitcoin could be banned by major governments such as the US and China which would severely reduce its rate of adoption, its level of network security, and its perceived potential
- Bitcoin’s protocols could be hacked or its encryption algorithms (SHA-256 and RIPEMD-160) broken for long enough to undermine trust in the network, leading to a cascade of events such as media scrutiny and panic selling before developers and the community have time to make the necessary fixes
- Bitcoin could be subject to miner collusion via a 51% attack or something less well-known, resulting in damaging behavior such as double spending and unconfirmed transactions, undermining trust in the network and slowing growth
- Bitcoin could stop growing as it reaches the transaction limit of its current 1MB blocksize which reduces user and transaction growth and / or increases interest in competing cryptocurrencies
These are just some of the risks that which we’ll discuss in future essays. Buyer beware. Really.
How do you buy bitcoin?
What I optimize for here is safety and convenience over price and flexibility. I want you to invest in bitcoin because it will go up many-fold in the years to come, so I’m not trying to optimize for saving a few percent in transaction fees. I want you to invest today, not “some time in the future”, and the simpler I make it for you, the greater this likelihood.
I live in the US, and thus my two primary purchasing services have been Coinbase and Circle. I preferred Circle for the longest time because they had lower fees and also carried insurance against your deposits, but Circle recently got out of the bitcoin buying game. So now I buy all of my bitcoins from Coinbase.
Why Coinbase? It’s well-funded. I’m familiar with their culture and some of their team. It’s as trustworthy and competent a service as you will find in the bitcoin world. And while they have some policies that may frustrate a small segment of users – from purchase fees to identification requirements – this is also part and parcel of why they’re a safer service than, say, buying directly from an individual you meet on LocalBitcoins.
By default, Coinbase also provides a wallet, so you don’t need to worry about creating your own. They even provide a vault service which is a safer, offline way to secure your bitcoins. However, at some point you’ll want to create your own wallets to diversify your holdings and to familiarize yourself with the cryptocurrency world. The Open Bitcoin Privacy Project publishes an annual ranking of bitcoin wallets that is a solid list of reliable services.
So if you want to buy bitcoin in the US, start with Coinbase. You’re charged a 1-2% fee, but you can buy through PayPal, credit card, and a bank account. You can even schedule recurring buys for dollar-cost averaging.
If that doesn’t work for you, try Xapo. Unlike Coinbase, Xapo requires a bank wire transfer to purchase bitcoin. But like Coinbase, both are secure and trustworthy. I’ve found Xapo tends to quote a higher price than Coinbase.
If you’d like to buy bitcoin without going through the process of sharing your personal information, you can try LocalBitcoins. This is a Craigslist-like service which helps you meet bitcoin buyers and sellers throughout the world, and arrange in-person meet ups. The risks here are like the risks of buying stuff from Craigslist, but heightened because unlike buying a used TV, bitcoin is harder to understand and it’s been a well-known honeypot for hackers. Having said that, here’s a solid guide on how to use LocalBitcoins.
An added benefit of buying from a service like Coinbase and Xapo is that they automatically come with an online wallet. A wallet is simply a way for you to store your bitcoin, like a leather wallet for your cash and credit cards. There are many types of wallets, with various levels of security and authentication and ease of use, and we’ll talk about the different ways to safely store your bitcoin in a follow-up essay. The short answer right now, if you’re a new bitcoin investor, is to trust Coinbase and Xapo if you use them. But make sure to turn on two-factor authentication: this is when you use a phone number or – even better – an app like Authy to generate a security code that provides an additional level of security over your password. Apps like Authy and Google Authenticator are safer than supplying your phone number, if a little more work. You find that more work typically means more security.
Again, I recommend these services for buying small amounts, up to $10K or so dollars. For larger amounts you can buy from the exchanges or use direct brokers. I’ll write about these in a future guide.
A quick note about tax treatment: currently the IRS regulates bitcoin and what they call “convertible virtual currencies” as property. What this means for the individual investor, as best as I can understand, is that the buying and selling of bitcoin is subject to capital gains and should be approached the same way you handle gains and losses on stocks and bonds.
Some more advanced ways to gain investment exposure to bitcoin
There are some other ways to invest in bitcoin and these will only proliferate in the years to come. I won’t spend a lot of time talking about them here, since this is a basic bitcoin buying guide, but I wanted to offer you a sense of the different flavors and options for learning.
More advanced investors can use exchanges to purchase bitcoin. The advantages include faster purchasing time, lower costs, and reduced fees. But it’s a more complicated tool to understand and you must use it properly to save money. Finally, the biggest risk is that you’ll simply lose your coins, because exchanges themselves are subject to constant attack. The biggest hacks in Bitcoin’s history have happened to exchanges (think Mt. Gox) because, in part, of their complexity. Coinbase has an exchange called GDAX. Other well-known exchanges (excluding China) include Kraken and Poloniex.
Bitcoin ATMS – of which there are 927 at latest count – are a convenient if expensive way to acquire bitcoins. Here is a useful map to find them. They often charge very high fees, but they’re considered safe and reliable. I’m not sure whether Bitcoin ATMs are really making money, but they exist for now, so take advantage of them if you like. I haven’t used one. The Swiss Railway operator SBB has even enabled bitcoin buying at their ticket kiosks, of which there are 10K scattered through the country.
You can now buy bitcoin derivatives. They work just like equity derivatives, but with an added layer of risk because, well, it’s bitcoin. I won’t explain derivatives here, but I just want to make you aware of the option. TeraExchange is one that I’m familiar with, although I haven’t used it, and I believe LedgerX is coming online soon when it receives its CFTC approval (one US regulatory body that is taking a lead on bitcoin regulations).
Investment products like trusts and ETFs
These are institutional products that provide you exposure to bitcoin without directly owning bitcoins themselves. If you’ve invested in index funds and ETFs then you’re familiar with this product type.
The best known US investment fund is the Grayscale Bitcoin Investment Trust which trades as the ticker GBTC on the US OTC Markets. There are others, including two Bitcoin exchange traded certificates listed on Nasdaq’s OMX in Stockholm that trade by the ticker COINXBT and COINXBE (for all practical purposes identical to XBT, but denominated in Euros).
A product generating lots of excitement – which has yet to be approved – is the first Bitcoin ETF called COIN which was created by the Winklevoss Brothers. Most people expect the SEC to approve it in 2017.
These products are popular with institutional investors who are sometimes limited in how they can invest, and because an additional layer of perceived experts reduces perceived risk. Compared to buying bitcoin directly, you’re safer from regulations and hackers. They make buying bitcoin as easy as buying a publicly traded stock and come with some tax advantages. For example, you can purchase the GBTC through your IRAs but you can’t directly buy bitcoin.
There are downsides, of course. You don’t personally own bitcoin, merely exposure to the asset. You don’t even have guarantees of how much bitcoin the product represents, because the ratio is rarely constant. So a $500 investment today might result in .75 bitcoin but as the investment product increases its assets, it might not increase its bitcoin holdings in proportion.
There are added rules and restrictions to how you can sell your position. And they usually charge fees. For example GBTC charges a 2% fee and COINXBT charges 2.5%.
It is the same as investing in a Gold ETF – you don’t own gold and can’t carry it with you during an apocalypse, but if gold increases in price, you will – more often than note – see an increase in the price of your investment.
There are many cryptocurrencies besides bitcoin. Ethereum and litecoin are two of the better known examples. Altcoins are to bitcoin what a small-cap stock like Twitter is to a large-cap stock like GE: even less volume, even more volatility.
I diversify a small portion of my cryptocurrency dollars into altcoins, mostly into ethereum, for reasons I’ll explain later. And over time, I’d recommend that you do the same. There are currently 643 cryptocurrencies listed on CoinMarketCap. Most of these are not worth your time or money. Some are scams. A few have genuine promise. All of them are volatile.
For the most part, I don’t believe altcoins are good investments. I put some money into altcoins because a) there is a small probability that bitcoin fails but cryptocurrencies succeed and b) some coins represent an interesting technological innovation that could lead to their success, which may or may not be correlated with bitcoin’s price.
Data shows that investing in an index fund of cryptocurrencies including bitcoins has not outperformed bitcoin itself. The network effects of money and the past performance of the industry seem to indicate that the safest, and smartest, investment is to buy bitcoin itself.
But the world of math-based currencies is a rising tide, and it will lift all boats. Bitcoin is the biggest and will remain so for some time.
Until you know what you’re doing, stick with bitcoin.
A final way to gain bitcoin exposure – perhaps the riskiest of all – is to invest in bitcoin and blockchain startups. Saying you’re a blockchain startup is kinda like saying you were a social startup when Facebook was exploding, or an Uber for X today. It pays to be skeptical.
But a quick look at AngelList shows 1062 cryptocurrency startups (!). As with any startup investment, the upside is a stake in the next Google and the downside is losing all your money. Like Marc Andreessen says, VC investing is not about batting average but slugging percentage. This means if you’re going to invest in bitcoin startups, prepare to make a lot of investments if you want the best chance of success. Then pray that one of them becomes a homerun. If you’re an angel investor, this means you should make at least 25-50 investments. Let diversification and the portfolio effect work its magic. Which means if you’re putting $10K (a small amount for an angel investor) into each startup, you’re looking at half a million dollars. With $500K, I’d rather invest straight in bitcoin. But that’s just me. There have as yet been no unicorn startups in bitcoin land (Coinbase might be the closest that I’m aware of), but that doesn’t mean we won’t see several examples in the coming years.