Next Gen Investing

Mark Cuban: This is the first thing you should do before investing in altcoins

Owner Mark Cuban of the Dallas Mavericks reacts against the Miami Heat during the second half at American Airlines Arena on February 28, 2020 in Miami, Florida.
Michael Reaves | Getty Images

Interest in altcoins, or alternative digital coins, like dogecoin, surged this year. And among the investors at the forefront is billionaire Mark Cuban, who has built a portfolio of different digital coins and blockchain companies.

His cryptocurrency holdings consist of 60% bitcoin, 30% ether and 10% other altcoins, he disclosed in April. His altcoin holdings include dogecoin, which he bought with his 11-year-old son Jake earlier this year, and litecoin, which he disclosed during a Reddit "Ask Me Anything" in February. He also owns DeFi, or decentralized finance, coins like sushi and aave.

Although Cuban has chosen to invest in altcoins himself, he has a key piece of advice for those considering doing the same. "It's like investing in anything else. Do your own research," Cuban, an investor on ABC's "Shark Tank" and owner of the Dallas Mavericks, tells CNBC Make It. "Altcoins are no different than stocks, bonds, private companies."

As with any investment, don't blindly copy what someone like Cuban is doing. And keep in mind that investing in cryptocurrencies, and particularly in altcoins, can be much more risky than stocks or bonds. Cryptocurrency is widely considered a highly volatile, speculative investment overall.

Recently, Cuban experienced these risks himself. On June 16, he revealed that he was trading a DeFi token from Iron Finance called titan that ended up crashing to zero in one day.

At first, some in the crypto world first speculated that this was the result of a rug pull, which is a type of scam where developers abandon a project and leave with investors' funds. Iron Finance denied those claims. The project said in a blog post that the crash was due to a "bank run," or panic selling, and the token's algorithmic code.

Though it's rare for altcoins to completely tank, it's a good reminder of how dangerous investing in crypto can be, and why you should understand what you're getting into ahead of time.

"Because their value doesn't really correspond to some underlying source of value — such as real estate, or profits or interest — there is almost no way to predict whether [cryptocurrency] will go up or down at any given moment," James Ledbetter, editor of fintech newsletter FIN and CNBC contributor, previously said. "It is pure speculation."

Know the risks of altcoins

Experts agree with Cuban that it's crucial to conduct thorough research before investing and only spend what you can afford to lose. If you're interested in altcoins, here are a few types of risk you should be aware of.

1. Reputation risk

Reputation risk is the threat that an altcoin project may not be in good standing. Before investing, it's critical to determine if the founders of the project are credible.

2. Market access risk

Market access risk refers to the accessibility of each digital coin, including where it's available for purchase.

If the altcoin is only available via an obscure backchannel, rather than a regulated exchange, for example, it may be worth thinking through the investment a bit more. If the method of purchasing a coin seems sketchy, it's possible the altcoin project is unsecure or a scam.

3. Technical risk

Technical risk is a big one, since the quality of code behind each digital coin can vary.

Many of the dog-themed altcoins, for example, were created by developers who copied and pasted the source code of other coins to create their own. Dogecoin, in particular, is a fork, or code copy, of luckycoin, which is a fork of litecoin, which is a fork of bitcoin. This can leave room for weaknesses within a code, making the altcoin potentially less safe and susceptible to bad actors.

It's smart to make sure that a reputable third party has audited and reviewed the code of any altcoin you're interested in buying. An audit will uncover if there are issues in a digital coin's development, including if it's possible for a central party to control the network or its funds, which could be potentially harmful and cause volatility.

However, even if a coin is audited, it's still possible for a sketchy project to slip through the cracks, so experts are clear: You should only invest as much as you can afford to lose.

As Cuban says, "always do the work."

Sign up now: Get smarter about your money and career with our weekly newsletter

Don't miss:

Mark Cuban says he took a 'hit' from crypto token crash
Mark Cuban says he took a 'hit' from crypto token crash

Disclosure: CNBC owns the exclusive off-network cable rights to "Shark Tank."