Since its creation in 2009, Bitcoin (BTC) has become a phenomenon in the world of finance. From Asia to Western Europe, millions of people have used the digital currency to transfer funds as well as purchase goods and services. For many, cryptocurrencies such as BTC represent the future of global commerce.
In addition to its functionality as a mode of payment, BTC has become a favourite among traders and investors alike. The following are the leading ways to engage the BTC markets:
- Cryptocurrency Exchanges
- Contract For Difference (CFD) Products
- Standardised Futures Contracts
Exhibiting consistent volatility and liquidity, BTC is an ideal target for active traders. The process of price discovery does not adhere to a peg, central bank policy or any traditional financial framework. Rumours, pending regulation and hacking are often primary drivers of BTC's value, which results in turbulent trading conditions frequently plaguing related products and markets.
Each method of trading BTC offers distinct advantages and disadvantages. It is up to the individual to decide which method is most suitable given the available capital resources and trade-related objectives.
The most conventional and popular way of trading BTC is through a cryptocurrency exchange. Much like a traditional cash or spot market, exchanges allow participants to buy and sell various types of cryptocurrencies in an over-the-counter capacity. For a fee, exchanges facilitate the buying/selling of BTC as well as other products such as Ethereum (ETH), Litecoin (LTC) and Bitcoin Cash (BCH).
The crypto markets are diverse and global, as are the exchanges that expedite their trade. For 2018, more than 1,700 digital currencies are in circulation with a capitalisation of more than £192.5 billion.
The immensity of the market has given rise to a multitude of venues specialising in the cash trade of cryptocurrencies. More than 200 exchanges offer active trading options on a 24/7 basis.
Exchange-based trading of BTC has its pros and cons. The advantages include user anonymity, speed of trade execution, market liquidity and diversity of options. However, issues such as fraud, vulnerability to hacking and lack of formal regulation can pose unique risks to invested capital.
Contract For Difference (CFD) Products
Contract for difference (CFD) products are financial derivatives based upon the pricing of an underlying asset. A CFD is an agreement between two parties to financially settle the difference between the initial value of a contract and its value at expiration. Stock indices, commodities and forex pairs are a few of the most commonly traded CFD products.
As BTC has gained acceptance from the financial mainstream, many brokerage services have elected to offer BTC CFDs to the public. These markets offer participants several distinct advantages:
- Leverage: BTC CFD products furnish traders with financial leverage to increase market exposure. Margins vary depending upon the broker and the individual CFD product being traded.
- Flexibility: CFDs give participants the ability to profit from being either long or short the BTC market.
- Easy Access: In many cases, forex brokers offer BTC CFDs for trade beside currency pairs, commodities and indices.
- No Ownership: When trading BTC CFDs, no ownership is assumed by the holder of the CFD. Contracts are financially settled by the brokerage, eliminating the need for a cryptocurrency wallet or storage facility.
CFDs are leveraged derivative products, which means they also have several potentially destructive downsides. The combination of leverage and the inherent volatility of BTC pricing significantly increases risk exposure. In addition, CFDs are traded according to a bid/ask spread, which is subject to change. As market conditions evolve, the bid/ask spread can become large, making the trade of BTC more expensive.
Selecting a reputable broker is also a critical part of trading BTC CFDs. In practice, the broker may act directly as the market-maker, taking the opposing side of the client's trade. Instances of market freezes and asset pricing discrepancies have been documented in the past. Another drawback is that CFD trading is not permitted in all jurisdictions, including the United States.
2017 was a big year for cryptocurrencies, especially BTC. By December 2017, its popularity increased exponentially, with valuations reaching nearly £15,500. As a result, BTC achieved widespread notoriety within the financial community. One product of the spike in public interest was BTC futures products being created and launched on several prominent futures exchanges.
A futures contract is an agreement to buy or sell an asset at a specific price on a predefined future date. Contracts based on equities indices, debt instruments, currencies and commodities are among the most frequently traded derivative products in the world. As of 10 December 2017, BTC joined the ranks of assets offered for trade as standardised futures contracts.
BTC futures products are available on two U.S. exchanges: the Chicago Mercantile Exchange (CME) and the CBOE Futures Exchange (CFE). Each contract offers a unique tick size, underlying quantity and pricing reference for BTC valuations.
Futures traders enjoy a wide variety of trading options and advantages similar to those found in CFD products. Two of the biggest are the availability of leverage and the flexibility to hold either long or short positions. Of course, enhanced risks associated with the use of leverage also apply. However, futures have two distinct edges over CFDs:
- Commissions And Fees: Brokerage commissions and exchange fees are assigned on an all-in basis instead of a variable spread. In times of extreme volatility, this feature keeps the cost of doing business static.
- Regulated Exchange: Futures exchanges offering BTC contracts are strictly regulated. The United States Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) are in charge of overseeing the BTC futures markets.
Industry insiders view the CME and CFE listings of Bitcoin futures as a starting point for the greater sector. In fact, the Intercontinental Exchange (ICE) is slated to list its own daily physically delivered BTC futures contract in late 2018. Upon regulatory approval, the offering from ICE will mark the third launch of a BTC futures contract.
Trading BTC On The Forex
Aside from cryptocurrency exchanges, CFDs and futures, BTC is traded on the forex. The market for BTC forex pairs is very similar to that of traditional currency pairings. Values are determined in relation of the base currency to the counter currency.
Available BTC forex pairs vary by broker. BTC is commonly traded against the United States dollar (USD), Australian dollar (AUD), euro (EUR) and Great Britain pound (GBP).
Similarities between BTC forex offerings and that of gold are evident. Gold is frequently traded against the USD (XAU/USD) in the same fashion as BTC (BTC/USD). However, gold has a physical commodity ultimately backing valuations and BTC does not. This difference is important, in that the debate over whether BTC is a currency or commodity is a hot-button regulatory issue that periodically influences its price.
When addressing BTC, and cryptocurrencies in general, it is important to remember that these markets are still in their infancies.
Innovative new methods of trading cryptos are being financially engineered on a regular basis. Futures contracts based on other leading cryptocurrencies such as Ethereum are reported to be in development. In addition, the world's largest asset-manager, BlackRock, has expressed interest in creating and launching the world's first Bitcoin ETF.
Ultimately, BTC and the entire cryptocurrency trading environment remain fluid. As digital currencies become integrated throughout the world of finance, it's very likely that fresh and exciting modes of trade will become realities.
Leverage: Leverage is a double-edged sword and can dramatically amplify your profits. It can also just as dramatically amplify your losses. Trading foreign exchange with any level of leverage may not be suitable for all investors.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…