The cryptocurrency market exploded on to the scene in late 2017, as bitcoin prices surged to more than 19,000. The crash that ensured was just as impressive as the rally. The benefits of the volatility were that several products were introduced that allow investors to speculate on the direction of cryptocurrencies.
There are now several different ways that investors can learn how to trade cryptocurrencies. This includes opening an account with a cryptocurrency exchange using a digital wallet, trading cryptocurrency contracts for differences (CFDs), trading cryptocurrency futures contracts or trading cryptocurrency exchange-traded funds (CFDs).
There are pros and cons with each method, but each allows you to take advantage of the movements in the cryptocurrency market.
Trading While Exchanging Assets
The first type of account that became available was an account that allowed investors and consumers to exchange sovereign currencies for cryptocurrencies or cryptocurrency for cryptocurrency. If you plan to use the account that you set up for trading as well as to buy goods and services, you will need to use this type of account. To start, once you open the account, you will be instructed to set up a digital wallet.
A cryptocurrency wallet is a software program that allows you to generate private or public keys, that enables you to send cryptocurrency to others that have keys. You can also receive cryptocurrency and monitor your balance. This is like a checking account for cryptocurrency.
How Do Digital Wallets Work?
The way digital wallet works is that your keys allow you to store records of transactions on the blockchain. The public and private keys that you hold interface with blockchain software and allow you to monitory your holding and send money via transactions. Each transaction is stored on the blockchain and is never deleted.
When you trade cryptocurrency and send your digital coins to another person you are signing away your ownership to another digital wallet address. To be able to spend the digital coins and unlock the ability to access the cryptocurrency, the private keys stored in your wallet must match the key where the digital coins are sent.
There is no actual exchange of the digital coins just a transaction that shows that the keys were exchanged.
Trading Cryptocurrency Using CFDs
If you are not interested in spending cryptocurrency there are many alternatives including using CFDs. A CFD is a financial instrument that tracks the movements of other assets. You do not own a key and are not transferring currency through the blockchain. You instead open a CFD account with a broker. Your broker might offer CFDs on cryptocurrencies such as bitcoin or Ethereum.
One of the benefits of using CFDs is that your broker will likely provide leverage. This means that you can use a margin account to enhance the returns. Some brokers will provide leverage of up to 10-1 on certain cryptocurrencies. With the exchange rate of Ethereum at 215 per US dollar, you could purchase one Ethereum coin for $21.5. You will only be responsible for the change in the exchange rate of a cryptocurrency and not holding or owning any cryptocurrency.
Trading Using Futures Contracts
If you do not have access to CFDs, which is the case in the United States, you might consider trading cryptocurrencies via a futures account. Futures contracts are the obligation to buy or sell an asset at a future date. Futures contracts also track the movements of cryptocurrencies. Futures contracts on cryptocurrencies are financially settled. This means that you never have to take delivery of cryptocurrencies and are only responsible for the change in the exchange rate.
Futures contracts are regulated in the United States by the CFTC which is part of the US Securities and Exchange Commission. Like CFDs, futures contracts provide leverage. This leverage allows you to enhance your returns. The futures exchange will increase or decrease the leverage that is offered to futures traders based on the volatility of each market. While futures contracts are remarkably like CFDs, they require a much higher initial margin in most cases.
A cryptocurrency ETF is like other exchange-traded funds. Generally, an ETF holds a basket of products and moves within tandem with these products. For a digital ETF to work properly the manager of the ETF needs to own the underlying products in a trust. The owner of the ETF will then gain exposure to the underlying assets held by the ETF.
The Bottom Line
The bottom line is there are several ways to trade cryptocurrencies. If you plan to use the cryptocurrency that you are trading to purchase goods and services, the most efficient way to do this is through a digital wallet. If you do not plan to spend cryptocurrency, then using an alternative method such as CFDs, futures contracts, and ETFs are more efficient ways to speculate on the direction of cryptocurrencies.