After surging higher in Q4 2020, bitcoin has consolidated its gains at the beginning of Q1 2020. Bitcoin trading has been lackluster during Q1, while Ethereum has taken the mantle and rallied in January 2021. The large moves in bitcoin and Ethereum have created a buzz around cryptocurrency trading and have led many new investors into this relatively new asset class. Investors can trade cryptocurrencies using a plethora of different tools that are offered by brokers and trading platforms. These mechanisms include using a cash account, using a CFD account, or trading exchange-traded funds (ETFs) that hold cryptocurrencies.
Trading Using a Cash Account
Several platforms provide access to cash trading of cryptocurrencies. To trade, you need to fund your account with a sovereign currency deposit (such as the dollar, Euro, Pound, etc.) into your account or deposit a cryptocurrency. If you never traded cryptocurrencies before, you are likely to deposit sovereign currencies. Some of the platforms that provide trading of cash cryptocurrencies are regulated, and some are not. Once you make a deposit, you can exchange or sovereign currency for a cryptocurrency at the current market exchange rate. Most platforms provide you with different orders, such as market orders, limit orders, or stop-loss orders. Once you exchange your sovereign currency for cryptocurrency, you will receive an address held in a cryptocurrency wallet.
For example, A bitcoin address is a unique identifier that serves as a virtual location where the cryptocurrency can be sent. People can send the cryptocurrency to bitcoin addresses similarly to how sovereign currencies can be sent to an account or email using Paypal. The standard format for a Bitcoin address is P2PKH (pay to a public key hash).
The address itself consists of 26-35 alphanumeric characters. Digital wallets or Bitcoin clients generate addresses through cryptographic operations. The software generates a private key through an asymmetric signature algorithm and then derives the public key from the private one. The user signs with the private key and verifies that signature with the public key.
The benefit of using a cash account to trade cryptocurrency is that you can send your cryptocurrency to any address. If you want to pay for goods or services using cryptocurrency, you will need a cash account to accomplish this transaction. The cons of using this type of account are that the commissions are more extensive than when using a non-cash account. For example, most platforms charge 0.2% per trade. There are also deposit fees that can be pricey. This charge compares to many CFD brokers that do not charge a commission or stockbrokers that do not charge a commission for ETFs.
Using Contracts for Differences
Another way to trade cryptocurrency is through contracts for differences (CFDs). A CFD is a financial instrument that allows you to speculate on a cryptocurrency direction without actually owning the underlying product. There is no need to set up a wallet and receive bitcoin through an address. Your CFD broker will provide you with a product that tracks the movements of the underlying product. You could trade cryptocurrencies like you would trade CFDs on oil or the S&P 500 index.
One of the key benefits of using CFDs is that you would have access to the same platform you use when trading other CFDs. Additionally, many brokers provide leverage, allow you to enhance the returns using a CFD. Most CFD brokers do not charge a commission making trading these products more cost-effective. If you plan to use your cryptocurrency to purchase goods and services, a CFD platform is not the best choice. You will not be able to send the CFD to another party. You have to cash out and go through the process of opening a cash account. The upshot is that if you plan to trade cryptocurrencies and not use them as a payment mechanism, a CFD broker is more efficient.
An Exchange Traded Fund (ETF) is a trust that holds other financial instruments. A few ETFs hold cryptocurrencies, which allows investors to benefit when the exchange rate rises or falls. There are usually no commissions when trading these products, but the bid-offer spread can be wide and less cost-effective than a CFD.
The Movement of Cryptocurrencies During the Past 6-months
In Q4 of 2020, after months of sideways price action, Bitcoin took off. The exchange rate roared into the new year. Since October 2020, bitcoin’s exchange rate relative to the US dollar has increased 3-fold, rising from 10,620 to more than 34,000. At one point in early 2021, bitcoin exceeded 40,000, which was an all-time high. Ethereum, the second-largest cryptocurrency by volume, also hit an all-time high in early 2021 but has consistently exceeded the $1,400 level. What seems to be clear is that the trend is upward sloping and may take the exchange rates on major cryptocurrencies higher during the balance of 2021.