Trading Crypt; the three ways of trading

In the previous post, I started the discussion on trading bitcoin, I gave out a background to trading bitcoin, I do hope you found it helpful. If you haven’t read that post yet, you can read it here.

In this post, I will discuss the three basic ways bitcoin and other crypto-assets could be traded. This guide is not only applicable to bitcoin but to other cryptocurrencies as well. There are some key terms that will try and explain in parenthesis.

How to Trade Bitcoin

There are three ways Bitcoin and other crypto-assets can be traded, check them out below:

  1. Buy the underlying from an exchange or online cryptocurrency broker (holding the actual currency in a wallet at the exchange or off-site)
  2. Trade (buy/sell) a CFD (Contract for Difference) derivative and hold cash margin with an online forex broker or multi-asset broker
  3. Buy a publicly listed security related to Bitcoin and hold shares with an online stockbroker.

Buying the Underlying (Actual) Asset: Pros and Cons

This option, which is to buy the underlying, you become the direct holder of the digital asset.

Underlying assets are the financial assets upon which a derivative’s price is based. Options are an example of a derivative. A derivative is a financial instrument with a price that is based on a different asset.

for more check here

Upon purchase, the cryptocurrency is sent to your bitcoin address or account (wallet) with the exchange. From there, you can transfer the cryptocurrency to any bitcoin address or wallet address using the private key that verifies you control ownership of the asset.

This responsibility to safeguard your private key which controls the digital asset also comes with some additional risks, as explained below. First, we will go over the positive sides of owning the underlying digital asset.

Pros

  • You control the actual underlying digital asset.
  • Most versatile option (can be transferred, sold, exchanged/converted).
  • Can be secured with the use of a private key or by the exchange’s wallet
  • No third-party counter-party risk when the private key is held in cold storage offline.
  • Multiple payment wallet options are available to store/transfer the asset.

Cons

  • Private Key that may be unique to each address must be safeguarded (your responsibility).
  • Technical knowledge may be required to carry out operations.
  • Lost private key may mean the asset is unrecoverable.
  • If the private key is stored at the exchange where you bought the Bitcoin, it could be hacked and your Bitcoin could be stolen from the exchange.
  • Third-party wallets can get hacked or subject to malware/phishing and your Bitcoin can get stolen.
  • If you keep the private key offline only (cold storage) and lose your private key and not able to recover it your Bitcoin is lost forever.
  • You must remember your password or private key if you store your Bitcoin electronically or be sure you can recover your private key (the easier this is, the more prone your Bitcoin is to potential theft by hackers).

Conclusion

For long-term investors who are willing to actively safeguard their Bitcoin, owning the underlying is clearly the way to go, but prudent steps must be taken to mitigate the risk of Bitcoin theft and/or loss of private keys (i.e., diversifying holdings across wallet/storage types, using two-factor authentication and strong passphrases).

Trading Bitcoin as a CFD/Derivative: Pros and Cons

CFDs or contracts for difference is a financial instrument that allows trader to participate in various markets that aren’t normally as flexible as the Forex market, but allows them to replicate that kind of leverage and granularity.

For more read here

Pros

  • Trading a CFD or derivative on Bitcoin negates the responsibility to safeguard any private keys.
  • The greater degree of leverage is usually offered on derivatives, so your cash margin can have more buying power (increased risk/reward).
  • CFD/derivatives permit shorting by opening a selling position without first having a long (buy) position, for those looking to speculate on a decline in prices of the underlying.
  • Brokers may be able to offer lower transaction fees, although spreads may be slightly wider or marked up, depending on the liquidity sources the brokerage uses.

Cons

  • Spreads (trading cost) are usually wider compared to trading the underlying.
  • Trades may be cancelled or reversed in the event the broker finds fault in its systems (price, etc.) or if it finds a client violates their particular account agreement with the said broker (agreements vary).
  • Clients rely on the creditworthiness of the online broker for managing any risk prudently and ensuring that it is well capitalized (less risk of going defunct).
  • Margin trading means there is a chance of a negative balance occurring in the case of huge market volatility, a gap, or other Black Swan systemic event.
  • In such cases, counterparty risk falls on the broker, which means if the broker declares bankruptcy, investors may suffer substantial losses and not receive priority among creditors.

Conclusion

Active traders looking to speculate on Bitcoin over the short or medium term may find that trading CFD/derivatives on Bitcoin using an online forex broker will provide them with 24hour trading, potentially lower margin, and the ability to go either long or short. Because of counter-party risk, choosing a broker is just as important as finding one with the best trading tools or commission rates.

Buying Bitcoin-Related Securities (ETFs, ETPs, etc.)

What is a Security?

A security is a fungible, negotiable financial instrument that holds some type of monetary value. It represents an ownership position in a publicly-traded corporation (via stock), a creditor relationship with a governmental body or a corporation (represented by owning that entity’s bond), or rights to ownership as represented by an option.

To read more check here

Pros

  • Trading a Bitcoin-related security that aims either to replicate the performance of the asset or act as a trust that holds Bitcoins where investors don’t need to hold private keys provides traders an alternative investment vehicle to buy and hold (long only).
  • Doesn’t require safeguarding private keys
  • Trades as a publicly listed security on exchange under exchange guidelines.

Cons

  • The price of the security and the price of the underlying asset (Bitcoin) may vary, causing a tracking error, either due to fees or other differences in the portfolio construction methodology.
  • The security may only be tradeable during exchange hours, and not 24 hours a day as is the case with Bitcoin.
  • Volume of the traded security may be less than the available volume of the underlying asset (making it illiquid).
  • Bid/ask spreads and other fees may be different than the cost of buying the underlying directly.

Conclusion

For stock market investors, investing in Bitcoin indirectly through a listed security such as an ETF, ETP, or trust may be suitable for those looking at taking a passive position. Active traders might find the limited trading hours and potential lack of volume a limiting factor that could hinder their trading. Overall, using listed securities that invest, track, or hold Bitcoin can be a viable alternative to diversify away from the risks of margin trading or safeguarding private keys when buying the underlying.

I hope that you have gained some insights into how the coin market works. I will suggest you study more and do personal research before you commence on trading.

See you in our next post. Do share, comment and come back for more.

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