Financial markets roared to unprecedented heights in 2021 with major stock indices and cryptocurrencies reaching all-time highs on more than a few occasions. The start, and current state, of 2022 however has been a different story. Though much of the market is down, one thing seems certain: a new generation of retail traders and investors have hitched themselves to the markets and likely won’t be going anywhere anytime soon.
Many of the traders and investors who entered these markets in 2020 or 2021 have racked up substantial profits, but there’s a key difference between getting rich and staying rich. 2022 has taught that lesson to many participants of the market through various situations. A famous example is the stablecoin Luna crash: $1 coin which was de-pegged early May and dropped to $0.13 causing billions to be wiped out. Understanding the difference between asset classes and how different trading strategies can influence results is an important part of retaining capital. Remember, capital accumulation and capital preservation are two different skill sets. Instead of overtrading into a choppy market, take some time to reevaluate your allocation and gain a deeper understanding of the different markets you’re involved with. Like stocks and crypto for example.
Cryptocurrency Trading
Bitcoin isn’t even a teenager yet, but cryptocurrency has already made an indelible mark on the financial markets across the globe. Cryptocurrency trading is the buying and selling of different digital assets. Buying and selling of NFTs can also be considered crypto trading, but today we’ll focus on the assets you find on exchanges like Coinbase and Gemini.
Let’s use Bitcoin for example. The actual digital asset of BTC is used to reward miners for their work in verifying transactions across the blockchain ledger. These rewards can also be bought and sold on the open market through cryptocurrency exchanges. When you buy Bitcoin from a cryptocurrency exchange, you’re purchasing an asset that was previously awarded to a miner for verification completion.
Digital assets like BTC and ETH act more like commodities than stocks with all of the gains coming from speculative appreciation. Cryptocurrency investors can also take their coins and earn interest using products known as ‘stablecoins’, which function more like unregulated bank CDs than commodities or equities. And of course, derivatives markets have entered the picture, allowing traders to wager on the daily price of a cryptocurrency through contracts known as ‘perpetual futures’.
Cryptocurrency Trading Pros and Cons
Pro: Potential for Large Returns – Cryptocurrency markets are volatile, even when trading the largest assets by market cap like Bitcoin and Ethereum. Risk-tolerant traders can rack up huge wins by stomaching the volatile ups and downs of cryptocurrency markets.
Con: Lack of Consumer Protections – Volatility is the only troublesome thing you need to stomach in crypto markets. Cryptocurrency is still in its infancy and the market is a bit like the Wild West. There’s no FDIC or SIPC protection on your deposits and exchanges and hot wallets (ie. online) are frequently hacked. Safely storing cryptocurrency can be an expensive endeavor.
Pro: 24/7 Availability – Stocks trade from 9:30 AM to 4:00 PM Monday through Friday. Currencies and futures trading is 24 hours, but shuts down on weekends. Cryptocurrency, however, is a truly 24/7 market that allows buying and selling at any moment of any day. While risk averse traders may not want to monitor investments at 2:00 AM on a Wednesday evening, crypto can be used, bought, sold, or exchanged freely at any time.
Con: High Transactions Costs – Unlike stock brokers, you’ll be paying a commission on both sides of your trade with a cryptocurrency exchange. And the commission is in addition to any network fees, which can vary depending on the congestion of the network. For example, exorbitant gas fees on the Ethereum blockchain have been a notable bone of contention for many cryptocurrency investors.
Stock Trading
Stock trading is a little simpler to understand. Stock is synonymous with equity because it represents an ownership stake in a public company. Unlike cryptocurrencies, stocks are backed by the valuation of the underlying business. Cash flows, intellectual property, real estate, patents, etc. are all factors that go into determining the value of a company. And unlike digital assets, stock can only be issued by the underlying company, which must jump through many regulatory hoops in order to avoid running afoul of the Securities and Exchange Commission.
Stocks are bought and sold on exchanges like cryptocurrencies, but most transactions actually occur via a broker, who acts as a proxy to the investor and finds the best available counterparty for the trade. Individual stocks rise and fall based on the performance of their underlying company, but baskets of stocks can be purchased as ETFs or mutual funds as well.
Stock Trading Pros and Cons
Pro: Deposits Are Insured and Markets Regulated – While market manipulation can still occur in stocks, investors can sleep a little easier knowing their deposits are federally insured and the markets are regulated. You can still lose money investing in stocks, but you’ll be made whole if your broker gets hacked and your funds stolen.
Con: Limited Trading Hours – If you don’t have access to pre- and post-market trading, you’ll be resigned to the hours of 9:30 AM and 4:00 PM. And guess when most of the major moves in stock occur: in pre- and post-market trading. The 24 hour nature of crypto helps even this playing field a bit by always trading.
Pro: Low Transaction Costs – Commission free trading is now the norm at most brokers and the spreads paid for trading liquid stocks is measured in fractions of a penny. Settlement can still be an issue for active traders, but the friction to buy and sell has been nearly eliminated.
Similarities Between Stock Trading and Cryptocurrency Investing
Despite what we’ve discussed so far, stocks and digital assets have many similarities. If you’re actively trading in either market, you’re likely hoping to accumulate wealth through speculation. While many consider this type of trading to be little more than gambling, active traders on both markets use similar techniques, such as using moving averages to detect changes in trend.
Additionally, stock and crypto exchanges work in basically the same manner. Both are continuous auction markets where buyers and sellers agree on a price in order to initiate the transaction. If you’re buying, that means someone else is on the other end selling.
And finally, stocks and crypto are similar based on how the federal government classifies them: property. You’ll pay taxes on stocks and crypto in the same manner via long and short-term capital gains rates.
Investing in Crypto vs. Stocks: Main Differences
The differences between the two asset classes are also stark. Stocks are backed by business assets like cash flows, inventory, and intellectual property. Cryptocurrencies have no hard backing other than the agreement on price between the parties trading.
Crypto trading is also far more volatile than stocks with tokens trading like penny stocks instead of large cap equities. Coins can see a Gala coin increase of 108% in a month or a Dogecoin drop off from a rally of $0.72 to now under $0.09 in a year. However, in recent news, stocks have been a victim of high volatility drop offs as well. One example being earlier in 2022 where Meta Platforms’ stock fell by more than 25% in one day. Other famous examples include GameStop and AMC stocks. Volatility of this magnitude isn’t for everyone, especially those on fixed incomes who depend on constant income streams. It’s important to do your own research and evaluate risk when investing in the market, especially crypto.
Finally, anyone can program and issue a cryptocurrency as long as they have the knowledge and capacity to institute the protocol. Stocks cannot be issued unless underwritten and approved by government regulators. For better or worse, only legitimate companies can issue stock to be traded on major exchanges like NYSE and NASDAQ.
Bottom Line
Both stocks and cryptocurrencies are vehicles for speculation and wealth accumulation, but the differences in volatility, underlying backing, and regulation means that some investors likely won’t feel safe with large amounts of capital invested in crypto. Depending on your appetite for risk, you might devote a large portion of your portfolio to crypto, a smaller percentage, or none at all. No two investors have the same goals, so use these markets in ways that make sense for your long-term financial plans.