What Are Cryptocurrencies?
You know as well as I do that Cryptocurrency currency trading has gone viral, and this viral trend only started in the middle of 2016. Hard to believe and this is remarkable given that Bitcoin, which can be regarded as the precursor of all cryptocurrencies, has been around for close to 10 years. In the early years, very few people wanted to touch it with a totem pole. Now, investors and traders are scrambling all over them, wanting to become the new set of cryptocurrency millionaires.
Cryptocurrencies were developed as a system of transactions based on a decentralized public ledger system, maintained on a peer-to-peer basis. This technology which came to be known as the Blockchain, is based on cryptography.
Where Can You Trade Cryptocurrencies?
Cryptocurrencies were initially created as a system of conducting transactions, using a ledger system of transactions that would not be centrally controlled by a government agency such as a central bank. Rather, control would be exerted on a peer-to-peer basis. Interest in Bitcoin, the first cryptocurrency began to pick up soon after it was created in 2008. As developers and some interested members of the public tried to lay their hands on it through mining, it became clear that mining was not a sustainable or cheap way of acquiring Bitcoin. This led to the birth of the first exchanges such as Mt.Gox.
Today, most of today’s cryptocurrencies are not obtained through mining but through exchanges. Exchanges provide an avenue to exchange fiat currency for cryptocurrencies, and to be able to acquire more cryptocurrencies by buying them cheaply, selling them more expensively for fiat currency and using the proceeds to acquire even more. The fact that it is not easy to expand the total amount of cryptocurrencies in circulation the way a central bank could simply print more money, has made exchanges even more popular.
The change in prices of cryptocurrencies as a result of demand and supply on the exchanges inadvertently created a new market: buying and selling of cryptocurrencies for money. Brokers in the forex and binary options market have now discovered that it is possible to offer contracts-for-difference on cryptocurrencies, allowing traders to trade the price differentials on a minute-to-minute basis without actually owning the cryptocurrencies themselves. Today, several brokers are listing BTC, ETH, LTC and other cryptocurrencies for trading on their platforms.
In the subsequent paragraphs, I’ll highlight the two main markets for trading cryptocurrencies and break down the entire process for everyone to understand.
A Review of Exchange-Based Trading
Exchange-based trading simply refers to buying and selling of BTC, ETH, LTC, Dash and Ripple on cryptocurrency exchanges such as Poloniex, Paxful, Bitmax, etc. Unlike the platform-based trading which will be discussed below, trading cryptocurrencies on the exchanges requires actual ownership of the “coins”. How is this done?
To trade cryptocurrencies on an exchange, you need the following:
- An account on a cryptocurrency exchange. Many of these exchanges now offer multiple cryptocurrency trading. Even the ones that offered BTC trading exclusively now offer ETH, LTC and others as well.
- A wallet with a unique wallet address. Some traders prefer to get a wallet from the mobile app stores, then link to an exchange. However, you can get one for free once you open an account.
Trading on an exchange requires buying a cryptocurrency from any of the other sellers on the exchange, and reselling when prices appreciate. Sellers usually showcase their cryptocurrency prices so you can pick from the list. Payment can be made with fiat currency or e-currency such as PayPal, Skrill, Gift Cards, etc. A fee is charged by the seller for the transaction.
The payment method you use in paying for your coins will affect pricing and speed of transaction because each method has its own charges for conversions. Usually, a chat must be initiated before any trades are made. Some verification processes will also need to be done by both buyer and seller. The buyer will release funds to the seller, who then release the BTC, ETH or LTC after confirmation. Transactions are handled via the exchange’s escrow account and the wallet address (which works like an account number) is used by both buyer and seller in the transactions.
For every transaction, notifications will be sent to both parties.
What are the contract specifications? Generally speaking, the following contract specifications are used when buying and selling BTC, ETH, LTC and other cryptocurrencies on exchanges:
- Pricing of cryptocurrencies is to the order of several decimal places. This can produce confusion when exchanging fiat currency for cryptocurrencies and vice versa. To this end, conversion calculators are provided to enable traders make easy two-way conversions of their holdings and intended purchases.
- You will pay transaction charges for purchase or sale made on a cryptocurrency. The payment method you use will determine how much money you make on any deal. So it is not just enough to make a profit from the purchase and resale of a cryptocurrency. You must factor in your transaction costs.
- All buying trades on exchanges are unleveraged. Traders are expected to come up with the full value of the cryptocurrencies being purchased.
There are some major drawbacks with exchange-based cryptocurrency trading. First, there is no stop loss facility. If prices start to fall, the trader either has to hold out until whenever prices bounce back, or sell off coin holdings at a loss. Furthermore, it is very possible to get scammed on exchanges.
This is why some traders decide to use the second model of cryptocurrency trading, which is trading cryptocurrencies as CFDs on the platforms of forex brokers.
A Review of Platform-Based Trading
Trading cryptocurrencies on trading platforms of brokers in the forex and binary options market is all about trading them as Contracts-for-Difference (CFD) assets. The actual cryptocurrencies are not owned during transactions. This enables traders to profit not just from rising prices, but from falling prices as well.
This changes the entire dynamics of trade. With this model, where you are in relation to the price is no longer important. Rather, it is what trade direction you assume that matters. In exchange-based trading, the trader has to be conscious of price levels so as not to buy when prices are too high and about to retrace. In platform trading, prices are not too high or too low. Has an uptrend gone too far and prices about to retrace? No problem. Find a technical entry point to ride the downside movement to profit from shorting the asset. This is the major advantage that platform-based trading has over exchange-based trading.
How do you carry out platform-based trading?
The first step is to look for a regulated broker that lists the various cryptocurrencies for trading. Usually, the cryptocurrencies are listed as pairings against fiat currency. So you have asset listings of cryptocurrencies displayed in this manner:
It is also possible to see listings of one cryptocurrency against another such as BTC/ETH, etc. However, the more conventional pairings see the cryptocurrencies listed against the US Dollar.
Once you have spotted a broker that lists cryptocurrencies, the next step is to open the trading account and submit all Know Your Customer (KYC) documents for verification of identity and address. You will receive your trading account number and password.
You may be required to download the trading platform of the broker, or use the web-based versions. Some brokers will even offer a mobile app. Once you have obtained a trading platform, you can login with your account number and password.
I will mention here that cryptocurrency trading on forex platforms can be done using leverage. This will also affect the margin requirements for trading cryptocurrencies. Leverage can compound profits and can also magnify risk, as will be shown later in this article.
Advantages of Trading Cryptocurrencies
There are several advantages of trading cryptocurrencies over other asset classes. Some of these are highlighted below.
- Cryptocurrencies can be traded all day, and all week long. Yes, you read that right. The cryptocurrency market does not bat an eyelid and can be traded every single day. Even the forex market, the only other 24-hour market, does not open for trading on Saturdays and Sundays.
- There are several cryptocurrencies that can be traded. So there are always market opportunities.
- Unlike the forex and stock markets, cryptocurrencies are affected fundamentally by only a restricted set of news events, making them a bit more predictable to trade.
- Anyone can trade Bitcoin, Ethereum or Litecoin on an exchange. There is no need to acquire a license to do this. This provides a low entry barrier. You need a license to trade currencies offline.
- Trading on an exchange gives actual ownership of the cryptocurrencies. Most people cannot own large amounts of physical currencies for trading, or crude oil, gold or silver.
- Ethereum gained close to 3,000% between January and July 2017. Bitcoin has nearly doubled in value from the July 2017 retracement levels. It is difficult to see such astounding price movements in other conventional markets. This wide range of price movements seen in cryptocurrencies provides for nothing short of pure opportunity for discerning traders and investors.
- There is a positive correlation that exists between several cryptocurrencies. After years of living in the shadow of Bitcoin, Litecoin has also started to see major price moves. Therefore, traders can benefit from sectorial correlations to make profit from trading.
- Some developers are working on cryptocurrency trading robots. Several software are already in the market, some of which are being used on virtual private servers.
- g) It is possible to use charts to conduct technical analysis on several cryptocurrencies. Indeed, traders with this knowledge can actually get ahead of the rest when dealing in cryptocurrency exchanges, using the knowledge to buy low and sell high.
Inherent Risks In Cryptocurrency Trading
Every coin presents with two sides, therefore we cannot expect the cryptocurrency “Coins” to be any different. Just as there are benefits to cryptocurrencies, there are also inherent risks.
- The ability to trade cryptocurrencies on trading platforms of forex brokers with leverage is a magnified risk factor. If misused by traders and they get caught out on wrong trades, the effects could be devastating if not properly managed.
- Those who buy and sell cryptocurrencies for profit on the exchanges are basically taking unmitigated risk. If prices start to crash (as has happened several times in the past), there is no way to put a stop loss to control your exposure. Once you have acquired cryptocurrencies, you cannot control their value.
- Traders who are not skilled in the act of risk and money management will suffer greatly if they get caught out by adverse price movements.
- Majority of retail traders are not skilled in professional fundamental and technical analysis. In the zero-sum market, only the best can profit at the expense of the losing traders.
- In the exchanges, there are many scammers. Despite the safety measures put in place by the cryptocurrency exchange operators, some scammers still fall through the cracks and perpetrate their awful acts.
- One major drawback of digital currencies is their susceptibility to hacking. In July 2017, hackers stole an estimated $7m in Ethereum tokens within a space of 3 minutes from CoinDash, after its Initial Coin Offering. A venture capital fund lost $50m worth of cryptocurrency to hackers in 2016. The danger of wallets being hacked is an ever-present one.
Cryptocurrencies can be traded on exchanges (involving ownership of the cryptocurrencies) or on trading platforms (as crypto CFDs). Each method comes with its pros and cons. Traders must understand the rules guiding each trade channel so as to be able to make profits at the end of the day.
Cryptocurrency trading has its advantages and can be a profitable venture. However, risks should not be ignored. They must be addressed even before trading is commenced.