There are a few different ways to trade bitcoin. Each of which has advantages and disadvantages. We will discuss each one and in detail and see which is the best way to trade Bitcoin. The different methods will depend on whether you want to trade short term or invest over the long term.
Many people have heard of bitcoin and for a while, it seemed everybody was making money investing in bitcoin. Yet, the price of Bitcoin like most assets goes up and down. The dramatic rise in the price of Bitcoin came to a spectacular end in early 2018. This saw many early investors lose large amounts.
Since then the price of Bitcoin has stabilised and the market has become more mature. Today there are a few different ways you can trade Bitcoins. There are also many other cryptocurrencies that have been created since.
What you need to know about various cryptocurrencies
Before we can talk about how to trade Bitcoin, we need to have an understanding of Cryptocurrencies. In Particular what has been driving the price and how we can get access to them. Investopedia says
“Cryptocurrency is a decentralized network based on blockchain technology. A distributed ledger enforced by a disparate network of computers”.
A defining feature of a cryptocurrency is that it is generally not issued by any central authority. This will make it immune to government interference or manipulation.
What this means it is very hard for any group or government to control the movement of these assets. Transfers are done “peer to peer” without a third party such as a conduit bank. Transfers will be done using a public key.
For traders, this brings opportunities and risks. On the plus side, it is easy to access and to follow the price movement. But no government can protect you from fraud. And no guarantee that any particular cryptocurrency will have any value in the long term.
Common types of Cryptocurrency
The first cryptocurrency mined was Bitcoin. This is still the most popular and represents 60% of all daily crypto trades. One of the technical issues with Bitcoin is that you can only mine a finite number of coins. Coins can be split into fractions, but this limitation led to the creation of other cryptocurrencies known as “altcoins”. A few popular ones are Ethereum, XRP, Litecoin, Bitcoin Cash and EOS. There are more than 2,000 cryptocurrencies that can be traded.
Different ways to trade
We will discuss four main ways to get access to Bitcoin.
1. Holding physical Coins
Holding the coins without any leverage. You buy the coins on an exchange or from another person holding the coins. You cannot hedge or short sell to profit from a downward market. You will also need a wallet to hold your coins. The best way to protect your physical crypto assets is that you keep your coins in an offline wallet. This should be encrypted and with a backup key in case, you lose your wallet. Some investors will keep some of their crypto assets online or with exchanges. This is more convenient but leaves them open to security breaches. Keeping your asset in a secured device is a must if you plan to keep your portfolio. This is known by the cryptocurrency community as being a "Hodler".
Disadvantages of the physical market are that you cannot short sell if you think prices will go down. You will have to ride and weather a down move in prices.
Another factor in dealing with a cash asset is that online crypto exchange such as Binance, Coinbase, Kraken etc. can get hacked. In 2014 one of the biggest crypto exchanges at the time Mt. Gox was hacked and $500 Million worth of bitcoins disappeared and they went bankrupt. You will need a wallet to hold your assets and this can be in your computer, portable device or hosted by a third party. You will need to back up your wallet on a regular basis. As long as your computer or device is connected to the internet, it will always be vulnerable to getting compromised. And that is why this is not the best way to trade bitcoin.
Trading futures brings transparency, liquidity and better price discovery on the crypto ecosystem. A futures contract has a standard contract size and an expiry date and is traded on a regulated exchange.
Late 2017, two of the biggest Futures Exchanges unveiled their version of Bitcoin Futures. Like CFDs, you can speculate on price movements or hedge your exposure in bitcoins. Both future instruments are in USD.
a) CBOE Futures- XBT has no leverage since it is set at 1:1
b) CME Futures – BTC/BRR and this has a leverage of 1:5
The disadvantage of trading futures is having to find a Futures broker that can execute or place your orders. Most online platforms are US based and only a few New Zealand brokers trade futures and fees are steep to trade this asset class. This system is only good for professional traders who trade on a medium-term time frame and need to hedge large exposure to bitcoin.
Futures exchanges typically only trade Bitcoins. They do not cover other popular cryptos such as Ethereum, Litecoin and Bitcoin cash and others which make up the other 40% of daily crypto trades.
3. Exchange-Traded Funds (ETFs)
ETF is a type of fund that owns asset like bitcoins or other cryptocurrencies and trade like normal shares on a stock exchange. They have a mechanism wherein they buy and sell enough underlying to mirror the price of bitcoin. But issuers of these ETFs have been applying for a bitcoin-based Exchange-Traded Fund but the SEC has denied or delayed each one. The closest to an ETF is GBTC which is a Grayscale Investment Trust. You have to take into account their price has a premium over actual bitcoin price. The SEC will allow the market to have a bitcoin or crypto ETF soon since trading ETFs is as easy as buying and selling stocks.
CFD is an over the counter (OTC) product that can be traded with a CFD broker. This mirrors the physical asset without owning the actual currency. Movement of the CFD price will follow the actual prices of the underlying instrument. Traders can bet on an upward or downward movement of the physical asset. Buying to speculate for an upward movement and short selling for a downward movement.
There are risks associated with trading CFD market. Cryptocurrency trading can get very volatile.
The advantages of trading CFDs is that you can leverage your positions between two or more times. This means you can trade with a smaller capital and have a potential for higher profits which means profits and losses are magnified.
It is also much easier to diversify your portfolio by buying different cryptocurrencies to spread the risk. Bitcoin trading is quite popular in a rising market. You can get a narrow spread between buying and selling which is perfect for day trading. A very important consideration of CFD trading is that you do not need a wallet to store your Cryptocurrency. Online trading can be done in a matter of seconds which is ideal for short term trading.
Trading bitcoin can be risky due to its volatility. In early 2017 Bitcoin ramped up from below $1000 to almost $20,000 by December.
In 2019 alone Bitcoin rallied from $3,300 to $12,500 by July and back down to $7,000 by December.
So generally, CFDs are good for active speculators who trade short term while the physical or cash market is suited to long term holders of bitcoin.
Even if you have a successful trading strategy when trading CFDs it is critical to select a reputable broker that will pay out your gains. Beware of “fly by night” brokers who are licensed out of the many “summery islands” like BVI, St. Kitts, or the Cayman Islands... Using one of these brokers might mean your investment might disappear overnight. There will be little protection or recourse with these type of companies.
Do your due diligence, take into account your broker’s credibility, stability and jurisdiction and platform. New Zealand has one of the toughest regulators, the Financial Markets Authority (FMA) even compared to the UK and US. Find a broker that has reasonable spreads, swap rates and efficient customer service.
Finally using CFDs is not ideal if you want to hold positions long term. Sure, the leverage means you don’t have to put up the full amount to buy the Bitcoins, but you will pay Swap fees each night. If you hold on to your position in a flat or consolidating market, the swap fees will add up and eat into your profits or add to your losses.
Investors should make a fair assessment of their trading objectives. Taking into account their capacity and hold positions long term or to day trade.
Using CFD trading is a great way to trade and the most popular platform for regular investors. With MT4 you can trade on your desktop, tablet or phone. But the caveat here is to choose a dependable and reliable broker that is locally based.
If you want to trade long-term, then it is better to buy bitcoin from one of the cryptocurrency exchanges and move it over to your wallet. Make sure your wallet is secure. This is like a gold buyer who only buys gold bars to provide cover for any geopolitical event or to hedge against strong inflation. The gold buyer makes sure to keep his gold bars in a secure place.
Ricardo Garrido - Senior account manager at Rockfort Markets Limited