For someone who is interested in cryptocurrencies or has possibly entertained the idea of speculating on cryptocurrencies as a form of investment, they would most likely have encountered the idea that to purchase cryptocurrencies that they would need to do so via an exchange. However, with the ever-increasing interest in the future of cryptocurrencies, a lot of people are now looking to explore cryptocurrencies as an investment class.
For instance, speculative interest has risen to the extent that the Chicago Mercantile Exchange has announced it will offer Bitcoin futures in Q4. While Bitcoin futures will no doubt be useful for some individuals and companies that will look to hedge risk with their own Bitcoin exposure, it also cements cryptocurrencies as a speculative asset class and formalizes the first-ever cryptocurrency derivative contract.
Derivatives are essentially an asset that has a price based on an underlying asset. For example, traders can trade gold futures but they do not own the underlying gold – they are trading a derivative contract that has a physical underlying asset (being gold).
So too with cryptocurrencies, traders who are interested in speculating on the future price movement can now engage in financial markets where they do not own the underlying asset (e.g. Bitcoin) but can take advantage and make profits based on the price movement of the “physical” Bitcoin asset.
With the ability to speculate comes the ability to trade on leveraged positions and we have seen a dramatic increase in the number of CFD brokers who offer cryptocurrency derivatives for speculators to trade in a leveraged environment.
So to the power of the investor, there are multiple ways that they can take advantage of the exciting cryptocurrency markets. Here, we discuss two ways in which investors can get involved in the worldwide phenomenon that is cryptocurrency trading: CFD brokers and Exchanges.
A CFD broker (Derivatives broker or Forex broker) specializes in derivative contracts. Typically CFD brokers will offer a wide range of assets that are most typically used for speculative purposes. These include forex, commodities, futures, bonds, and indices. Most recently, global CFD brokers have added cryptocurrencies as new asset clients for investors to trade.
When trading with CFD broker investors do not ever own the underlying asset that they are trading. For example, an investor may trade a derivative contract for silver, but they are never going to “take delivery” of the contract and exchange their funds for actual silver. What they are trading is a contract for difference – the difference in profit/loss from the point of entry to the point of exists on a trade. There is usually no predefined period that trades can hold a position on a particular asset. So if they wanted to open a trade on Bitcoin, they could do so and hold on to that trade for minutes, days, months, or even years.
By trading with a brokerage, traders can take advantage of the leverage that brokers offer clients. Leverage increases traders “purchasing” power in the market. For example, by trading with 20:1 leverage, this means that traders can trade an asset valued at 20 times the amount of capital in their account.
Thinking especially of Bitcoin, for instance, if the price of Bitcoin is $9,000 USD and a trader opens a single contract with 20:1 leverage, this means they only need $450 in their account to trade a Bitcoin contract – making it much more accessible for speculation than buying actual Bitcoin.
The other key feature of trading with brokers is the regulation that is required in order for the broker to operate. Brokers generally require a large amount of capital backing and have strong compliance standards based on the financial licenses they hold. So there is an inherent sense of confidence that comes with trading with a highly regulated broker.
The key advantages of trading with a CFD broker are:
- Access to leverage to get more buying power in the market
- Increased regulation and compliance
- Easy to use funding and withdrawal methods
- Easy to use trading platforms
- More aligned with traders who wish to speculate on future prices
The key disadvantages of trading with a CFD broker are:
- The trader does not own the underlying asset
- Access to capital invested is not as liquid as with exchanges
More commonly individuals with interest have heard of crypto exchanges. These are financial companies that allow clients to exchange cash for cryptocurrencies and offer the additional service, or at least in most cases, of providing clientele with access to a crypto wallet to store their purchased digital currency. As cryptocurrencies are at core a peer to peer exchange, a crypto exchange is an entry requirement where an individual can at first purchase a cryptocurrency, which then allows them to engage in peer to peer buy/sell exchanges with no middle man.
Crypto exchanges act similar to a stock market in that clients can buy or sell cryptocurrencies at a market price or even set up limit or stop orders where they wish to buy or sell at a future price. The services provided by crypto exchanges entail either a flat commission fee paid by the client or an increased spread on the market price (e.g. the buyer buys at a slightly higher price or a seller sells at a slightly lower price).
Individuals wanting to purchase or sell cryptocurrencies via an exchange will need to register an account with a particular exchange and go through a series of security steps to authenticate the individual’s identity. Once the account is set up and a purchase is made, the exchange pays the cryptocurrency into a secure wallet provided by the exchange along with providing the client with a unique encrypted key to access their digital currency. A client can then transfer the funds, should they wish, to their own personal crypto-wallet, or even to hardware specially designed for storing cryptocurrencies.
One of the key advantages of dealing with exchanges is that when storing funds in an exchange provided wallet, the client has quick access to liquid funds that they can sell or trade at their discretion. Another key benefit is that the client actually owns the underlying asset and they go on to use the digital currency as they choose – buying goods and services from other peers using the crypto market. Unlike brokerages, however, exchanges are often not as well regulated and may fall victim to cyber-attacks. Choosing the right crypto exchange must be done with thorough research.
The key advantages of trading with an exchange are:
- Access to a variety of cryptocurrencies that may not be offered at brokers
- Quick access to liquid funds that can be used to purchase other products or services
- The individual owns the underlying asset
- Once a cryptocurrency is purchased, users can participate in anonymous peer to peer exchanges
- Easy to use deposits and withdraws
The key disadvantages of trading with an exchange broker are:
- Exchanges are often not well regulated and may be more open to cyber attacks
- No access to leverage, so it is a 1:1 buy/sell environment