Cryptocurrency Trading – What Is It And How Does It Work?
Richard Montana | March 8, 2022
Unless you live under a rock, you probably know what cryptocurrency is. Yet, if you still haven’t understood its actual functioning, then let’s do a quick recap. Cryptocurrency is a digital asset or currency exchanged through a computer network between two parties without a central regulatory authority. This computer network is part of a technology called Blockchain that ensures the authenticity of the transactions. Some of the most popular cryptocurrencies like Bitcoin, Ethereum, Litecoin, etc., are based on Blockchain. These currencies are stored in a digital wallet which can either be hardware-based or web-based.
Like other currencies of the world, the value of each cryptocurrency is unique and fluctuates based on various factors. Still, unlike the state-backed currency, cryptos only exist in a record of ownership shared across the Blockchain network. Whenever an owner of a cryptocurrency wants to make a transaction, they send it to the other party’s digital wallet. However, this transaction isn’t completed and stored as a record on the Blockchain until verified. This verification process is called mining and is also the process of creating a new currency.
Cryptocurrency trading can be quite daunting and challenging because of its volatility. So it is important first to understand the very basics of the process. For starters, the exchange of the assets happens in two forms ‘fiat to crypto’ and ‘crypto to crypto.’ The second part is the method of trading which also consists mainly of two types Contract of Differences (CFD) and Regular crypto exchanges.
- CFD route – This type of method allows an investor to speculate the price movement of cryptocurrency and bet on it. Here, you will not own any part of the cryptocurrency as you are just speculating the price trajectory of the crypto asset. These contracts often don’t require you to put down a lot of money as there is no ownership involved, and the difference in the value of opening and closing prices is paid. If the price prediction is right, it works in favor of the trader, and if not, the difference has to be paid by them. It is imperative to know that these price movements are speculated in various pairs and works mostly like the CFD trading in the stock market.
- ETF route – The exchange-traded fund route involves buying the asset through an exchange platform. This method can either be long-term or short-term, depending upon the nature and strategy of the trader. Unlike CFD, exchange trading is much less volatile and gives the trader to make far-sighted strategies. The profit and loss in this method are determined by the rise and fall in the cryptocurrency price. As mentioned above, this trading can be done either through fiat-crypto pair or in crypto-crypto pair.
What is a cryptocurrency marketplace?
A cryptocurrency marketplace is an exchange platform that allows users to exchange cryptocurrencies for other currencies (fiat or digital). If you are keen on starting your crypto trading journey, you must understand the various types of crypto exchanges. The three main types of exchanges are:
- Centralized exchanges – These are third-party exchanges and are like the brokerage platforms available for stock trading. Being centralized makes these types of exchanges counter-intuitive to the idea of cryptocurrency, i.e., decentralization. But having a private owner of the exchange means a certain level of ease it provides to the traders. Almost every centralized exchange uses fiat currency as a method of exchange. Although, these types of marketplaces are more prone to cyberattacks because of being held by a single entity. Funds in these exchanges are held in the exchange wallet, an entity of the exchange itself. Hence, the increased risk of losing your investments in a cyber-attack scenario.
- Decentralized exchanges – On paper, decentralized exchanges are much more secure than centralized exchanges and are closer to the idea of cryptocurrency because it has no single managing authority. The drawback with these accounts is that they don’t have a super-smooth exchange process like centralized marketplaces. You may not always find an option of using fiat currency, bank transfers, or using your debit card to buy crypto assets on these exchanges. Users hold their funds in personal crypto wallets.
- Hybrid exchanges – These exchanges result from efforts to bring the best of both worlds. On these platforms, users control and deposit their assets with the speed of centralized platforms. In the coming days and years, hybrid platforms will increase their user base.
If you have decided to start your crypto trading journey, you must carefully choose your exchange platform. Below are a few points that you can run through before finalizing on the exchange that you will trade on-
- Place of business: know where the exchange platform is based demographically and in which jurisdiction. Choosing a platform from a crypto-friendly nation will save you from harsh government restrictions.
- Security: It is one of the most important factors. Choose a platform with a long history with minimal security issues. Also, see if they are insuring your assets.
- Liquidity and fees: You don’t want your exchange to run out of business. Do some research on its financial health and also ensure if its brokerage fees suit you or not.
- Available currencies: Does an exchange have enough currencies or the ones you want to trade-in? Always check for this question before opening an account.
Factors that move the market
Now that you know the underlying ideas of cryptocurrency trading, it is time to get acquainted with the factors that move the value of the cryptocurrencies and the market itself. The very basic factor involves supply and demand, just the way prices of things worldwide are determined. But unlike other things in the world, the value of cryptos is not heavily affected by the economic and political sentiments of the world because of its decentralized nature. Though there are contributing factors mentioned as follow:
- Supply of assets – This is the total number of coins present in the market. This factor is also a function of the rate at which a particular cryptocurrency is created, lost, or destroyed.
- Market perception – The way crypto is developed and gets updates lends to is a market perception amongst investors and traders. Public opinion about cryptocurrencies is also shaped by media activities and covered in the relevant forums.
- Viability and Utility – If a cryptocurrency is accepted and integrated as a form of payment at various places, it certainly has increased demand. It is to be understood that these factors keep changing with new developments in particular cryptocurrencies and the overall market.
- Key events – This is where events like war, economic stress, and other traditional factors begin to play their role. As humans living in the traditional currency system, we can’t completely rule out the influence of worldly activities on the cryptocurrency market.
Key elements of cryptocurrency trading
Like stock trading, cryptocurrency trading also has some key terms that you must know about:
- Lot – It is a batch of cryptocurrencies used as a standardized size of a trade. It is common to have lots of one unit of the base price of the cryptocurrency. Although, some cryptos have bigger lots.
- Spread – It is the difference between the buy and sells price of the crypto. Like conventional markets, if you want to open a long position, i.e., buy and own the asset hoping that its price increase, the price quoted to you will be slightly higher than the market price. Whereas when you want to open a short position, i.e., sell the cryptos you don’t own; you will be quoted a price slightly lower than the market price. In a short position, a trader gains when the asset price goes down and they buy back the sold asset at a lower price.
- Margin and Leverage – Leverage is the method of having exposure to a large sum of cryptos without paying for it in full. This leverage is multiple small deposits you put down, known as Margin. When you close a leveraged position, your gains and losses are entirely based on the leveraged sum. Margin requirements vary from broker to broker. It is crucial to note that while leveraging opens gates for bigger gains, it also leads to bigger losses.
Job prospects in the cryptocurrency trading
Cryptocurrency trading is not just buying and selling of cryptos and their contracts. The whole system requires a lot of human skillset and technology to run the trading system. Some of these jobs are:
- Blockchain and Software developers – Either a centralized exchange or decentralized exchange platform, both require technology professionals for the development and maintenance process.
- Security engineers – The ones who make sure that all the wallets and the exchange platform are secure from attacks.
Nontechnical jobs in cryptocurrency trading are
- Portfolio Manager – Individuals who manage the investment of other people in cryptocurrencies
- Trading Strategists – These people build trading strategies for big funds, using their knowledge of cryptocurrencies