Since its electronic inception in 2009, cryptocurrency – whether its Bitcoin, Ethereum, Litecoin, and others – has grown from a largely-unnoticed blip on a computer screen to a worldwide phenomenon, making and breaking fortunes through its often-volatile trading patterns and soaring growth trends.
Table of contents [Hide]
- Types of Cryptocurrency
- What is Cryptocurrency Trading?
- Other Ways to Gain Exposure to Cryptocurrency
- Cryptocurrency Exchanges and Brokers
- Choosing a Cryptocurrency Brokerage
- How Cryptocurrency Broker Trades Work
- How do You Make a Profit on a Trade?
- Cryptocurrency Risks
- Moderating Risks
- Final Thoughts
Types of Cryptocurrency
Collectively known as altcoins, there are now over 1,000 types of cryptocurrencies in existence, including the granddaddy of today’s cryptocurrency trading market, bitcoin. Active altcoin traders are spoiled for choice.
However, less active or fledgling cryptocurrencies may have limited trading opportunities, which could mean fewer buyers when it’s time to sell. Beginning traders who don’t wish to be overwhelmed by options can consider focusing their initial trading on some of the leading types of cryptocurrencies to help ensure trading into an active market:
Bitcoin currently represents 38% of the market and Ethereum represents 18% of the market, which makes these two cryptocurrencies the overall bulk of the market. Ethereum launched in mid-2015, giving an indication of how quickly things can change in cryptocurrency markets.
Other cryptocurrencies are actively traded but may be less commonly available at exchanges:
- Litecoin (LTC)
- Zcash (ZEC)
- Dash (DASH)
- Ripple (XRP)
- Monero (XMR)
Cryptocurrencies are generated by specialized computers through a computational alchemy called mining. Its relative rarity due to the processing power required to produce new coins is part of what gives a cryptocurrency its value. Additionally, some cryptocurrencies have a limit on the number of coins that can ever exist, also called a finite supply.
What is Cryptocurrency Trading?
In many ways, cryptocurrency trading can be compared to forex trading; the markets in various fiat currencies from all over the world are traded against each other. In Forex trading, U.S. dollars can be used to purchase a position or option in euros, Swiss francs, or any other currency, and then sold again at the time of the investor’s choosing, booking either a profit or a loss on the trade.
Cryptocurrency trading is very similar to forex, allowing traders to purchase cryptocurrency with U.S. dollars. As with forex, cryptocurrency traders can trade with a buy-and-hold strategy or trade the daily or weekly up-and-down volatility. There are even several strategies available by which you can potentially profit from a cryptocurrency going down in value, including futures contracts and binary options.
Due to volatility in Bitcoin and altcoin trading and the frequent use of leverage in these types of trades, betting on a downward move in price, called shorting, generally isn’t recommended for less experienced traders.
With Bitcoin itself trading for thousands, it might seem like the cost is price-prohibitive for most traders to take a position, but Bitcoin and other cryptocurrencies can be purchased as a decimal-based fraction of a coin.
While Bitcoin is limited to 21 million coins, about 17 million of which are in circulation, the ability to trade partial Bitcoin allows for each of those 21 million coins to be split 100 million times — theoretically. In practice, current exchanges don’t support such small units in trades. Most exchanges allow you to specify an amount you want to buy in U.S. dollars. The exchange computes how much Bitcoin or other altcoins you can buy with that amount.
Other Ways to Gain Exposure to Cryptocurrency
Investors seeking an easier way to invest in cryptocurrencies can now invest in funds that purchase Bitcoin or altcoins. These funds can carry a significant premium when compared to direct trading, but they simplify cryptocurrency ownership as well as providing a way to gain exposure to cryptocurrencies in more conventional investment accounts, like IRAs and personal accounts.
The most well-known cryptocurrency fund is Grayscale Bitcoin Investment Trust, trading as GBTC. The success of this fund led Grayscale to launch four more cryptocurrency funds: Bitcoin Cash Investment Trust, Ethereum Investment Trust, Litecoin Investment Trust and XRP Investment Trust. Higher expenses with funds can produce lower returns than with direct cryptocurrency trading, but funds can provide other advantages and can be purchased through many conventional investment accounts.
Cryptocurrency Exchanges and Brokers
To trade in cryptocurrency directly as opposed to investing in a fund, you have two choices: use an exchange or use a Forex broker. With an exchange, you are buying and selling bitcoins or altcoins directly.
With a Forex broker, you are buying a CFD (Contract for Difference). As the name suggests, a CFD does not give you ownership of the digital asset, the cryptocurrency. For this reason, and for portability, many cryptocurrency traders prefer exchanges — and sometimes utilize more than one exchange.
Choosing a Cryptocurrency Brokerage
Now, all you have to do is pick an exchange to use. Here’s a short list:
How Cryptocurrency Broker Trades Work
The mechanics of a cryptocurrency trade depend on the marketplace or exchange but usually are either similar to stock market broker trades with buyers and sellers each posting their respective orders at set prices and quantities — or are like buying from a market maker who buys and sells to traders at a fixed price that is usually close to the market price.
A full-featured exchange, like GDAX, provides traders with an experience closer to what they might find with an online broker, including posted bid and ask prices that indicate the price at which traders are willing to trade as well as the quantity. Typically, there is no charge for canceling limit orders on a full-featured exchange if the price doesn’t reach your target or if you change your mind. Market orders, however, aren’t reversible.
How do You Make a Profit on a Trade?
Much like stock market investing, gains or losses on cryptocurrency are on paper — or its digital equivalent — until an exchange event or sale takes place.
It seems like an oxymoron to discuss long-term trends with cryptocurrency when the second most popular currency is less than three years old. However, looking at the charts of the leading cryptocurrencies since their inception, the overall direction has been up, sometimes like a rocket. Many cryptocurrency traders don’t trade much at all, but instead, bet large parts of their position on long-term gains.
Cryptocurrencies can be among the most volatile of investments if you watch the short term price action. Fortunes can be made or lost in the often-significant up and down swings of even the most established cryptocurrencies. If you’re an active stocks day trader, you’ll find many of the same technical indicators in cryptocurrencies, although often amplified.
Warren Buffett contrasts cryptocurrencies to owning stocks, suggesting cryptocurrencies have no intrinsic value beyond their relative rarity due to difficulty in mining and finite amounts, such as with Bitcoin which is limited to 21 million coins.
However, the same can be said of many other assets in which we place value. If enough people think a thing is worth money, it’s worth money — at least for a while. Governmental risks can be a concern. It’s hard to imagine that governments won’t regulate a currency or try to squash one that can’t be easily regulated.
The SEC has already taken a stance, labeling cryptocurrencies as securities while claiming the trading platforms are potentially acting illegally and should fall under SEC regulation. While not illegal (yet), cryptocurrencies have been seized by authorities in relation to other criminal charges.
Cryptocurrency failure rate
Despite the headlines, cryptocurrencies have a high failure rate. Nearly half of 2017’s Initial Coin Offerings (ICOs) failed. These currencies never got off the ground or failed after fundraising. Another large group disappeared without a peep, bringing the expanded failure rate to nearly 60%. The next big thing could easily be the next big black hole.
Similar to diversification in other investment types, risk can be managed by diversifying a cryptocurrency portfolio. Going “all in” on one currency can be ultra-risky. Due to the volatility of cryptocurrencies, beginning traders might also want to start slowly and build a position over time, similar to dollar cost averaging in stock investing. Many traders also only trade with a fraction of their available funds or holdings.
Keeping some of your money out of harm’s way might limit gains, but it also limits losses, allowing you to continue trading — and perhaps you’re wiser from the experience. Note: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.
Between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
Cryptocurrency is one of the most exciting new asset classes the markets have seen in a while. Because the market is still young with few consumer protections in place, the burden is on the trader or investor to stay safe.
Any given cryptocurrency can gain favor or fall into cyber-obscurity seemingly overnight, which provides an opportunity to get in on the ground floor of the next big thing — assuming the floor doesn’t give way. For the near future, cryptocurrencies are here to stay and they’ve already created their fair share of millionaires.
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