It is easy to get swept up in the crypto craze when you read those eye-catching headlines about how someone turned 100 dollars into 10,000 with cryptocurrency. But here is what those success stories almost never tell us: the latent expenses that can silently eat away your profits before you even notice what is going on.
If you are interested in crypto investing, it is not just a choice to be informed of these costs, but a necessity. We will deconstruct the actual costs that any crypto investor incurs and how to reduce their effect on your returns.
Whenever you purchase or sell cryptocurrency, you are paying trading fees. They could sound trivial, only 0.1–0.5% per trade, but they accumulate more rapidly than you would imagine.
Suppose you are an active trader and trade 10 deals a month with a charge of 0.25% per way. That is 0.5% per full trade cycle, or 5% of your portfolio value monthly in fees alone. Within a year, your portfolio might lose 60% or more in trading expenses alone.
You are not immune, even if you are a buy-and-hold investor. That first purchase cost and subsequent sale cost can simply consume 1–2% of your investment off the bat. Some sites have flat fees on smaller trades that can be a large percentage of your business.
Find exchanges which have tiers of fees, which decrease as the volume of trading increases. There are also platforms that give discounts on their fees if you hold their native tokens.
This is where it becomes extremely tricky. The IRS in the United States considers cryptocurrency a property and not money. This implies that each and every transaction, and exchanging one crypto with another, will be taxable.
Purchased Bitcoin and sold it to Ethereum? That's a taxable transaction. Used Bitcoin to purchase? Taxable. Staked or mined crypto? Also taxable as income.
The tax consequences are even more of a difficult situation when you take into account:
Short-term vs. long-term capital gains: If you have a holding of less than one year, you will pay ordinary taxes on your income (as high as 37%). Keep longer than a year, and you rank under long term capital gains rates (0%, 15% or 20% on the basis of income).
Wash sale rules: While these rules do not currently apply to cryptocurrencies, proposed legislation could change this. This would prevent you from claiming losses if you buy the same asset again within 30 days.
Record keeping: You must record the cost basis, purchase date and sale date of each transaction. Miss it, and you may end up paying more tax than what it was required to pay.
Most investors are surprised by their tax bill. The size of the tax bill on crypto gains might be in the thousands, particularly when the trader is actively trading in a bull market.
Slippage is the gap between the anticipated price of a trade and the price actually executed. It is especially vicious in crypto markets, where the prices can fluctuate drastically in a few seconds.
This is how it works: You order a market buy of $1,000 dollars worth of a cryptocurrency at $50 per coin, and hope to receive 20 coins. However, when your order is executed, the price has soared to $52 per coin, and you have received 19.23 coins. The additional $38.46 was simply gone because of slippage.
Slippage hits hardest when:
Dealing out less liquid altcoins
Placing huge orders in comparison to the day-to-day trading activity
Trading in volatile times
Using market orders instead of limit orders
The 24/7 nature of the crypto market implies that slippage may happen at any point of time, and that it tends to be more severe during off-peak hours when the level of trading is lower.
All the transactions in a blockchain have network fees, and they may be very expensive. During peak times, the gas charges on Ethereum have been very high and have extended to over $50 on a simple transaction. Even the costs of Bitcoin can be more than $20 when there is network congestion.
These fees affect you when:
Moving crypto across exchanges
Transferring money to your personal wallet
Engaging in DeFi protocols
Minting or trading NFTs
The frustrating factor with network fees is that they are unpredictable. One day, you may spend $5 to transfer Ethereum and the next day, you may spend $30 on a transfer depending on the congestion of the network.
Before diving into any cryptocurrency investment, conducting comprehensive crypto analysis becomes crucial not just for identifying opportunities, but for understanding the total cost of ownership. It is not only the price charts and the sentiment in the market that should be analyzed, but also all the costs involved in it should be broken down.
Intelligent investors analyze the fees on various exchanges, taxation of various trading strategies and the network costs of their preferred cryptocurrencies. They also study the liquidity level to forecast the possible slippage and include such costs in their expected returns. A trade that looks like it's going to be a good one might actually end up being a loss once you've thought about all the costs involved, if you don't do a thorough analysis first.
Such a line-by-line examination will assist you not only in deciding what specific cryptocurrencies to purchase, but also in deciding what platforms to trade in, when to trade, and how to organize your purchase. It is the difference between risking and investing strategically.
The majority of exchanges impose interest on deposits and withdrawals. Bank deposits may not be charged, but wire transfers may be $15–25. Cashing out cryptocurrency to your personal wallet is usually subject to network fee and a service fee charged by the exchange.
Depositing via credit cards is easy but costly because the charges can be 3–4%. Even bank transfers through ACH can be free, but it might take several days to clear and hence you may miss trade opportunities.
The difference between the best price that the buyers can pay (bid) and the best price that the sellers can get (ask) is the spread. This spread is a profit to exchanges, and it is another expense to you.
Spreads are usually tight on the large cryptocurrencies such as Bitcoin and Ethereum, at below 0.1%. However, with smaller altcoins, spreads may be 1% or higher. This is equivalent to you being down 1% at the moment you purchase, even before the price changes.
You know the costs now, so here is how to cut the costs. Select the appropriate exchange based on the fees structure: some exchanges have low fees but wide spreads, and others have the opposite. Time your trades to prevent high volatility, where the slippage and network costs are greatest. Use limit orders rather than market orders so you can regulate the price you pay and prevent slippage. Premeditate taxes by maintaining detailed records and think about holding investments more than a year, to qualify for the long-term capital gains. Rather than carrying out numerous small transactions, you might want to consider batching transactions to minimize the overall fee expenses.
Resources in education are huge in this process. Platforms like CCN provide valuable educational content that can help you understand market dynamics and make more informed decisions about when and how to trade, potentially saving you significant costs through better timing and strategy.
While crypto price predictions can be tempting to follow, remember that frequent trading based on short-term predictions often amplifies all the costs we've discussed. Long-term investors usually also concentrate on fundamental analysis, as opposed to attempts to time the market, which naturally limits their exposure to trading costs, slippage, and short-term capital gains taxes.
Investing in cryptocurrency is more than choosing the correct coins, it is a question of managing costs. These unidentified costs can easily transform a successful trade into a failed one, and particularly to a small investor or an active trader.
The cost of ownership is a mathematical calculation you have to do before your next crypto investment. Consider trading commissions, possible taxation, network expenses and slippage. Then, and only then, can you tell whether an investment opportunity is really profitable.
The crypto market is full of amazing possibilities, and to succeed with them, it is necessary to do more than just to buy low and sell high. It involves knowing and reducing the expenses that can eat silently into the returns. Understanding these implicit costs and budgeting to them will help you accomplish your investing objectives when working in the unstable world of cryptocurrency.