While writing his Master’s thesis on the topic of encryption, out of curiosity Kristoffer Koch decided to invest 150 kroner or approximately $27 in Bitcoin. A sum that can hardly buy you a t-shirt today, back then in 2009 was enough to get you 5 000 BTC. With the time passing by, Koch started to forget about his investments, until the day when cryptocurrencies started to become a main topic on the news. Needless to say, after figuring out what his wallet key was, he was pleasantly surprised to find out how wealthy he has become.
FOMO – identified for the first time in 1996 by Dr. Dan Herman, the fear of missing out describes the desire to remain connected with the things that other individuals are doing.
Unfortunately, for every Kristoffer Koch type of story, there are hundreds of others that end up with investors losing all of their invested capital due to the extreme volatility and unpredictability of the cryptocurrency markets. The reason for that, most of the time, is the so-called FOMO phenomenon. Although having a much more complex psychological explanation, the Fear-of-Missing-Out basically defines one’s striving to become a part of the mass and not get left behind. FOMO is usually associated with new and increasing addictions. In today’s world, cryptocurrencies are proving to be one of the most popular addictions.
A new asset class – the same old investing principles
The desire to generate wealth overnight makes investors focus on the search of the next cryptocurrency unicorn. This can prove costly if the individual acts rashly and lets himself be guided by emotions, rather than rationality. Although cryptocurrencies have transformed financial markets, they are not writing their own history or being entirely disruptive. The digital asset class remains dependent on basic economic theories and principles such as supply and demand, need of diversification, transparency and stability, etc. Even more – when investing in cryptocurrencies, due to the higher volatility and associated risks, individuals should pay greater attention to the way they manage their portfolio. The history has proved that neglecting basic investment principles may wipe out one’s portfolio in a matter of days.
5 costly mistakes that investors make when choosing ICOs instead of crypto index funds
The power of blockchain nowadays paves the way for companies to come up with innovative solutions, combining the digital coins’ high growth potential and the time-tested stability of more common investment classes. This brings an efficient way to navigate the cryptocurrency markets and helps investors avoid some of the most common mistakes.
1. Fail for the gigantic rewards that ICO projects usually promise.
The problem. In the face of ICOs, nowadays the digital economy offers the easiest way for investors to get funding. All that a project needs to attract investors’ interest is a promising idea, described in a white paper, uploaded on a website. Investors are often lured by the exorbitant profits that projects
That is why, for 2018 alone, there are almost 1 000 ICOs launched already with more than $20 billion raised. But the truth is that most of the ICOs fail. A research by the ICO advisory firm, Satis Group, reveals that just 8% of the ICOs with a market cap of $50m or more, end up being traded on an exchange, while only 3.8% of them are successful and use the raised funds to fulfil the idea behind the project. The disturbing fact is that 81% of all ICOs turn out to be scams which means that at no point had their owners have the intention to deliver what they have promised.
Furthermore, a Boston College study points out that 56% of all projects die within 4 months of their ICOs.The fact that currently there is no regulation that can protect investors from scam token sales, alongside with the desire to find the next BTC tricks investors to put their money in risky projects when they can turn their attention to more secure, yet profitable crypto asset classes.
The solution: Do a careful research and invest in time-tested instruments. Take into account the market indications and choose the coins with the biggest market caps. Although most of the large-cap coins have reached a state of maturity and may not offer you the same growth potential, you will still be able to take advantage of the benefits of cryptocurrency investing, without most of the associated risks. For example, crypto index funds provide the chance to get sector-specific exposure and generate high returns by taking advantage of the industry breakthroughs. Apart from that, by investing in established and time-tested coins, you avoid unproven and highly-risky projects, thus preserving your capital.
2. Put all your eggs in one basket.
The problem. Even if you believed that you have found the next “golden goose” of the cryptocurrency world, do not make the mistake to allocate all your capital to a single asset. Over the past 2 years, cryptocurrencies have proved to be the most volatile asset class. Although some investors focus solely on BTC, thinking that as a leading coin it will provide stability over the long-term, historical data points out that even the benchmark for all digital coins has a 30-day volatility estimate of 5.4%.
The solution. It was way back in 1952 when Harry Markowitz proposed the idea of the Modern Portfolio Theory, highlighting the importance of diversification. Ever since then, the concept of investing in more than one instrument to reduce risk and increase performance has been a mainstay in the world of finance.
Crypto index funds are designed with the idea of combining different cryptocurrencies to increase the performance of the portfolio, while at the same time ensure efficient diversification, minimizing the effect of potential losses on the overall value of the investment. Although most coins are linked to the price of BTC, it is always better to invest in an index fund of multiple cryptocurrencies, so that you can reap the rewards of coin-specific breakthroughs, leading to a better overall performance of the whole portfolio.
3. You are not entirely familiar with the type of the instrument you are investing in.
The problem. Investors often make the mistake to back projects only because of the potential demand for the goods or services that they are expected to provide. The main problem is that there are different types of tokens – utility, security, asset, reward and currency. If the investor does not do his homework, he may end up with tokens that have no investment application or such which price is heavily dependent on the issuer, like the utility or the reward ones. The utility tokens, for example, are also known as “app tokens” and can be used only internally – to buy a product or a service from the issuer on his platform. The case is quite similar with the reward ones as they are more of a gamification element, rather than having any real-life or investment application.
The solution. Investors that struggle to find information about a particular project is better to back off and find better alternatives. Instead of investing in a single project and hoping for it to not get bust within a few months, capitalize on the industry potential by investing in a crypto index fund. The proposed scenario has plenty of advantages – you benefit from a fully-diversified portfolio, ensure more stability and achieve better performance.
4. Neglect the need for transparency for that “disruptive” idea.
The problem. You will find lots of people on social media promoting coins and market moves that will result in exorbitant profits. Each and every investor is tempted by the idea of extraordinary returns. As human beings, it is in our nature to get obsessed with wealth. Such situations make us take rash decisions and suppress our rational thinking. And this is exactly what differentiates the successful from the unsuccessful cryptocurrency investor. The first seeks transparent and trusted projects to invest in, while the latter focuses solely on the potential of high returns. Financial crises and the one from 2008, in particular, have taught us that there is no such thing like extreme returns with low risks. Everything comes at a cost and, in the last few years, ICOs have proven to be very costly.
The solution. Focus on the transparency factor and don’t try to find the next crypto phenomenon as you will most probably end up disappointed and with a solid money loss. Successful investors seek instruments that allow them to keep everything on track and have total control. And total control equals transparency and trust. BitFinding’s crypto index funds, for example, are self-auditable and allow individuals to track the performance of their investments, as well as check the records and find out all information for every single trade that was executed.
5. Choose an investment based on its potential and neglect history.
The problem. Although in the ever-evolving financial world of today, estimations based on historical data may not be perfect, currently we do not have any better alternative. More often than not, historical data can help us derive accurate projections for the future performance of a certain asset. When it comes to ICOs, the lack of historical data leaves investors with one major factor less to take into account when making investment decisions. Combine that with the impulsiveness and the temptation of becoming the next Kristoffer Koch, and there is the perfect recipe for that 81% ICOs running away with investors’ money.
Investing in cryptocurrencies is usually considered a relatively risky decision. Add to that the element of reckless investment behavior driven by the projected rewards, while at the same time neglecting the need of doing a proper initial research, typical for our human nature, and the huge per cent of successful pump-and-dump schemes becomes quite reasonable.
The solution. Do not forget that the only guarantee is the one of the market itself. Find instruments with high market cap and combine a few of them to get larger exposure and reduce the associated risk. Go further and focus on backtesting. Nowadays, this is not that highly-complex, luxurious feature, accessible only to programmers or data scientists that it used to be. There are plenty of user-friendly solutions that help you test how your portfolio would have performed back in time. That way, based on the best-performing scenarios, you can find a ready-made solution or even tailor a personal one that will help you achieve your personal investment goals.
Making your first steps on the cryptocurrency market is a really important process. Tempted by the huge rewards potential, novice investors often pour all their capital on a certain promising idea. The reality is that nowadays investing in ICOs is no different from crowdfunding campaigns – investors are basically donating to a concept and hope for it to become a reality. Furthermore, statistics point out that more often than not, their capital is lost in the moment when it is invested. Allocating all your capital at a scam project and losing it can be very discouraging for younger investors.
On the other hand – crypto index funds are here to stay. Through diversification and individually-tailored risk preferences, they can ensure a steady and guaranteed performance, based on cryptocurrencies with a proven track record. Add to that the fact that there are no investment minimums and you have the perfect instrument for investors with less capital.