Cryptocurrency Trading – How it Works
Cryptocurrency is rapidly becoming one of the most widely used financial trading platforms on the internet. The digital currencies like Ethereum and Litecoin have become quite popular amongst the users. People use these digital coins for not only trading but also for purchasing commodities over the internet. Bitcoin, which is primarily the oldest digital currency generated over the internet, is still the most popular mode of transaction in the cryptocurrency market.
You may also want to read:
How to Profit from the Volatility of the Cryptocurrency Market
Cryptocurrency is relatively a new concept that has taken over the digital world by storm. People are still trying to understand how they can benefit from the cryptocurrency market. Here is a guide on how you can generate financial income using digital currencies.
How Cryptocurrency Trading Works
Digital currency traders are always on the lookout for people who want to either buy or exchange popular cryptocurrencies. These traders deal either on popular digital currency exchanges like coin base or directly over the counter with other buyers. A ‘traditional’ currency exchange works more like a normal stock exchange. It consists of Buyers or sellers, brokers like 4XFX or Exchanges like Coinmama , and even market makers. To start trading on a currency exchange you need to have two important things in your trading vault:
- Digital currency wallet
- Funds to buy or cryptocurrency to sell on the exchange
Just like you would keep your hard currency like US dollars or Euro pounds in your physical wallet, you keep digital currencies in your digital wallet. Digital currency wallets are designed using sophisticated database schema so that you can hold all the currency you want while occupying minimal space on the internet.
Cryptocurrency market solely depends on how securely your financial transactions can take place over the internet. Therefore, when deciding what wallet you choose for digital currency trading you need to consider:
- The cost of subscribing for the wallet
- The level of security that the wallet provides
- How vulnerable it is to online hackers
The backbone of cryptocurrency exchange is the ‘blockchain’. Although it is considered by many as the most secure way to keep a record of financial transactions, it is also the most targeted one by hackers. To protect your coins from a hack, you can choose from a few different types of wallets:
Wallets Available on the exchange – These wallets are offered by exchange companies as part of their trading package. Since these digital vaults lie at a central repository, they are quite vulnerable to external threats.
Online Wallets – Apart from exchanges, there are companies that provide wallets to individual subscribers. These companies may charge a higher fee, but their firewalls and security systems are slightly better than the online exchanges. Even though these are quite secure, they are often the target of hackers since they hold a vast amount of important financial data.
Software Wallets – Like any other program, software wallets are installed on a digital currency user’s Personal Computer. The users can do their trades and then store their coins locally on their computer. One of the benefits of having a software wallet is that it has multiple options on its dashboard to choose from. The dashboard allows users to swap currencies and create a customized view for their own use. Although this is one of the most secure ways to hold digital coins, a computer virus or malware can disrupt the software in an instant.
Hardware Wallets – By far, this type of wallet is considered by many as one of the most secure ways to perform digital currency transactions. As the name suggests, hardware wallets hold your coins in a physical wallet just like a USB holds your data in a physical drive. The wallet is connected to the computer using a USB cable and can be detached by the users as they please.
What we have explained so far may help the reader gain insights about digital currency trading and the essential components required to trade Bitcoins or any other digital currency. The next step for an aspirant digital currency trader is to select an exchange where they will trade their digital currency.
Here are a few examples of most commonly used digital currency exchanges available to users all over the world:
Traditional Exchanges Including Coin base
Just like any other stock exchange, cryptocurrency exchanges are online trading platforms that match buyers with sellers through brokers that act as the middlemen. There are two major differences between a regular stock exchange and a digital currency exchange:
- Digital currency exchange is less regulated than a stock exchange
- Unlike stock exchanges like NYSE or LSE, there is no physical presence of any entity required in a digital currency exchange.
Brokers are the main component of a digital currency exchange. They are responsible for matching the seller with a suitable buyer. Brokers may offer guidance to digital currency traders based on the movement in the market. For their services, the broker may charge a service fee to their clients.
Trading platforms like coin base provide currency wallets as well. This means that traders can buy, sell and store their coins on such platforms.
Direct Trading
As the name suggests, direct trading occurs between a buyer and seller without any intermediary between them. What this essentially means is that sellers can put up a number of coins on sale seeking buyers to match their price. If a buyer is willing to offer a lower amount, both parties may settle on a common ground. These currency exchanges take place over the counter and are less expensive than trading on a traditional currency exchange. Such form of cryptocurrency trading usually takes place in areas where exchanges or brokerage houses do not exist.
Although direct trading is a less expensive form of trading, it has its own share of security issues. Since you never know who you are dealing with on the other side, direct traders need to conduct thorough research about the other party. The trades need to take place in a manner that each party receives its due share in time.
Digital Currency Brokerage
Cryptocurrency brokerage houses are like regular money exchanges that you find in public locations like an airport. What these brokerage houses do is buy a certain amount of digital currency available in the market and offer it on a premium to approaching customers. Although these types of currency exchanges are usually expensive they are quite secure and the transaction can be authenticated easily.
Most Popular Digital Currencies in the Market Today
Cryptocurrencies are one of the least regulated financial instruments currently available in the market. This allows the digital currency issuers to issue multiple currencies every year. More than 1600 currencies are currently in circulation in the digital world. However, there are some that have performed far better than the others. Here is our top pick for the currencies to invest in today:
Ethereum
Ethereum was launched in 2015 and has fast become one of the most popular currencies on the internet. The platform that Ethereum offers to its users is decentralized and highly suitable for developers willing to develop distributed applications for currency trading. Some of the best features of this currency include secure trading, reliability in transactions, and easy availability in the currency exchange market.
Litecoin
One of the oldest digital currencies around, Litecoin is referred to by many as silver in digital currency trading. The currency was a brainchild of an MIT graduate who worked at Google as well. Litecoin is based on an open source and distributed application framework that allows the currency to be scripted and decentralized. This provides additional security that makes the Litecoin block virtually impossible to crack. Although launched after Bitcoin, Litecoin is considered by many as faster currency to transact with.
Bitcoin Cash
The currency is an offshoot from the original Bitcoin and made a huge name for itself in the global cryptocurrency market. The currency came into existence due to the fork or argument between the developers and the miners of the original Bitcoin. Although Bitcoin cash is based on the same platform as bitcoin, there are some changes that make this currency more efficient than its predecessor.
Blockchain
Experts suggest that the backbone behind the whole cryptocurrency market is a collection of blocks that hold confidential information about each user and the transaction they make using cryptocurrencies. The major difference between a blockchain and any other cryptographic ledger is that blockchain is based on distributed architecture. What this essentially means is that there is no central depository or authority that holds the general ledger for all digital currency transactions taking place over the internet. In fact, the ledger is formed by blocks of code that are encrypted and stored in a number of distributed PCs. The only link between a block and its successor is a private key that provides the location of the next block in the chain. Each block may contain useful information about the transaction such as:
- Details of the sender, receiver, and the amount of digital currency they are willing to exchange between each other.
- A fingerprint which is a unique ID attached to each block for reference purposes.
- The chain is formed by the reference to the successor from the previous block.
Alternative Ways to Invest In Cryptocurrency
There are two essential ways that people can use to invest in a cryptocurrency without buying the currency itself. These options include:
Investing in a Trust
Trusts are companies that trade in a regular stock market. One of the most common cryptocurrency trusts that is frequently used by digital currency traders is called the GBTC – Global Bitcoin trust. What this company does is buy the Bitcoin in bulk from the pool of money collected from investors.
AS the value of Bitcoin goes up, so does the value of GBTC stock. The stock trades on some of the most popular stock exchanges include Dow Jones and NYSE. This is an effective way for new investors to try their luck in cryptocurrency. Since these trusts offer stocks, there is no need for the stockholder to apply for a digital wallet or create an account on a digital currency exchange.
However, there are some drawbacks associated with investing in a trust. Firstly, the investment is made in a single currency which means there is no ‘upside’ in case that particular currency starts to plummet. Also, it is usually not easy to withdraw your cash from a trust account. There is a considerable amount of paperwork involved before you can get back your money.
Digital Currency Funds
Funds are a true alternative investment vehicle for any type of assets’ class. The managers of these funds use multiple stocks or digital currencies to ‘hedge’ the risk of their portfolio against a falling market. A digital currency fund, for instance, may invest in multiple currencies and fix a ratio of each currency type in their investment portfolio. This allows them to minimize the downside risk in case there is volatility in the market.
Investing in a cryptocurrency fund has its downside as well. The premiums that people have to pay to be a part of these funds are higher than what a broker would ask for. The reason for this high-interest rate is due to the fact that the fund manager needs to do a lot of work to promise higher returns to their investors.
Quick Tips on CryptoCurrency Trading
To make their investment worthwhile, digital currency investors need to keep a few things in mind before they start cryptocurrency trading:
- The digital currency market is more volatile than a regular stock exchange.
- Diversification is the key to hedging your portfolio against risks.
- Investors need to do thorough research before selecting a currency to invest in.
Cryptocurrencies are one of the most volatile asset classes currently available in the financial market. This mode of financial transaction is becoming one of the most popular means to buy and sell commodities in the online space. Investors looking for an asset class that can give them a high return in a relatively short span of time should definitely consider adding cryptocurrency to their investment portfolio.
