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3 Important Things to Know About Bitcoin

Kayleigh Kulp

Bitcoin and other cryptocurrencies have become hot investments with seemingly Cinderella-esque, get-rich-quick potential, but before diving into this new asset class, most investors should pump the brakes.

Bitcoin, ethereum, ripple, litecoin and IOTA, for example, are types of digital currency that use cryptography to regulate how and when units are created, as well as to safeguard secure transfer of funds, says Billy Funderburk, a certified financial planner with Funderburk Financial in Longmont, Colorado. Blockchain is a public ledger of sorts that records cryptocurrency transactions anonymously. The cryptocurrencies could then be used to buy things or held for future appreciation.

Such currencies are intriguing in part because they are unregulated by governments, limited supply, and privacy in financial transactions. But they are also complex instruments to understand, purchasable only through specialized online venues, and are not so cheap anymore, making them risky investments, experts say. That is despite their promising potential for growth.

"It is important to recognize that the cryptocurrency market is still in its very early stages, which usually translates into huge opportunities for first-movers with good execution," says Duncan Rolph of Los Angeles-based Miracle Mile Advisors. "It is also accompanied by substantial risk for investors as there will likely only be a couple of winners over the long run."

[See: 7 of the Best Stocks to Buy for 2018.]

The price of bitcoin fluctuates wildly, bouncing between $12,600 and $19,100 in the last 30 days. A year ago, bitcoin was about $800.

"Despite naysayers like me, the price of bitcoin will never come down," says Joe Pindar, director of strategy, at Gemalto, an international digital security company. "The absence of sell-side pressure means that retail investors will push the price of bitcoin to stratospheric levels."

So before you jump into the crypto game, consider the following tips:

Decipher between investing and speculating, and do so in small doses. Don't buy a cryptocurrency just because it's the trendy thing to do.

If bitcoin or another cryptocurrency becomes something that is held as part of institution portfolios, then its value will go up, but that remains to be seen, says Rob May, co-founder and CEO of Talla, which builds intelligent blockchain assistants, and founding partner of Half Court Ventures, a cryptocurrency investment firm.

If you decide to invest, do so only with what you can afford to lose and have an exit strategy, Funderburk says. Keep an eye open for less hyped cryptocurrencies that will likely build on bitcoin's strengths and even be better.

One way to get in the game without having much to lose is using disposable income, such as selling stuff in your basement you were going to throw out anyway, says James Song, CEO of Exsulcoin, a blockchain technology company.

"If you make any substantial gains, sell off enough to recover your cost basis. If you buy $100 worth of a coin and it increases in value to $120, sell off $100 of the coin and put it back into your pocket. Let the remaining $20 ride the upside wave," he says. "That way, if it all crashes tomorrow, you're not losing anything. That's the best play to make for the next six months of 2018."

Know the technology. People interested in cryptocurrency should know how it works, how it is used and the value it creates and for whom.

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"The fastest way to lose your money as investor is to buy into an asset class that you do not understand," says Amine Rahal, tech entrepreneur and founder of Crypto Radar, a cryptocurrency magazine. "You should not invest more than 10 percent of your portfolio into cryptos and only if you can tolerate high risk."

It's also crucial to know the fundamentals: Blockchain is a technology that can be used by anyone, while cryptocurrencies are "stored values," just like any other currency, so their value has little to do with the underlying technology they employ to execute transactions, Rolph says.

And almost all major cryptocurrencies, like IOTA and verge, are based on ineffective or unsustainable technology because their dynamic "blocks" that store information vary in size, Song says. If lots of people start using them, block sizes get bigger -- so big that only large server farms can handle the processing. "That's centralization; exactly what we are trying to avoid with blockchain," Song says. "Blockchain ... was built to be tamper-proof."

If any of these cryptocurrencies release products that inadvertently expose user data or are hackable, it would void their value, he says.

Keep on top of regulatory attempts and the political climate. "More governments will announce plans to regulate bitcoin by controlling the transfer of [dollars or euro] into it," Pindar says. "That's not to mention that major investigations could launch to target more than $100 million in unpaid taxes related to bitcoin [or other cryptocurrency] gains."

"I believe the regulatory uncertainty and certain areas of investing are still very unclear for those wishing to fund endeavors through cryptocurrency," says regulatory and enforcement attorney Braden Perry of KennyHertz Perry in Kansas City, Missouri, who is also a Digital Currency Council certified professional.

"Potential investors will ask if there are compliance risks, regulatory risks, or legal issues, "he says. "As always, transparency is the key to understanding these novel risks that most industries don't have."

[See: 7 ETFs That Let You Invest With the 'Smart Money'.]

"What goes up can also go down," Ralph says. "Volatility goes both ways, so remember these investments can go right back to zero just as easily as they can go up another 1,000 percent."

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