Thanks to the volatility of the crypto markets, savvy traders are enjoying speculating on their price movements in hopes of finding positive trading opportunities. One of the most popular crypto trading approaches is spot trading.
Spot trading is a common investment method and offers traders a way to invest and trade in financial assets with ease. Many crypto traders' first interaction with cryptocurrency will be a spot transaction. Where they will make a spot transaction in the spot market, for example purchasing Bitcoin at the market price, and HODLing the coin until it rises in value.
In this article, we'll explain how spot trading works in the crypto market and some of the differences between trading cryptocurrencies as a spot product or a CFD.
Spot trading in crypto is the process of buying and selling cryptocurrencies at real-time prices with the aim of generating a trading profit.
Unlike investing in crypto, which typically involves holding (or “HODLing”) a crypto asset for the medium or long term, spot traders typically buy and sell a range of cryptocurrencies in an attempt to generate regular short-term profits.
When engaging in spot trading, you take ownership of the actual cryptocurrencies you buy and give up ownership of the cryptocurrencies you sell. This differs from trading crypto CFDs, for example, where you trade a financial product that tracks the price of a cryptocurrency as opposed to the actual cryptocurrency itself.
The core idea of spot trading is to buy low and sell high as often as possible to maximise trading revenues.
To illustrate how this works better, consider the following examples using Bitcoin (BTC) and the popular dollar-backed stablecoin Tether (USDT).
Bob places a buy order to get an equivalent BTC amount of 1,000 USDT at $48,000/BTC. Bob is matched with Alice who offers to sell him BTC for USDT at the aforementioned price.
Immediately when Bob and Alice reach an agreement, the order will be filled and executed. Bob will receive 0.0208 BTC, while Alice will receive 1000 USDT.
If, after a day, the price of BTC increased to $49,500/BTC and Bob decides to sell his coins, they would be worth approximately 1,029 USDT, meaning Bob made a profit of 29 USDT.
If after a day, the price of BTC decreased to $46,500/BTC and Bob decided to sell his coins, they would be worth approximately 967 USDT. Bob made a loss of 33 USDT.
A spot market allows traders to buy and sell an asset at prevailing market prices. Crypto spot market transactions are settled on the 'spot' immediately after the order of both the buyer and seller is filled. A spot market must include buyers, sellers, and an order book.
You can decide to trade different cryptocurrencies in specific pairs of your choice in the crypto spot market.
The crypto spot market, in general, is subject to huge fluctuations that are reflections of market sentiments from traders. These sentiments are driven by several factors that push traders to buy or sell. Spot traders often make use of different fundamental analysis and technical analysis techniques to make trading decisions.
Crypto spot markets are available over the counter, peer-to-peer, on centralised exchanges, and on decentralised exchanges. Let’s take a look at each type of crypto spot market.
OTC spot trading takes place between two parties outside of crypto exchanges. Dealers/brokers act as market makers by quoting different prices at which they will buy/sell a cryptocurrency. OTC trading often comes cheaper than exchange trading and the price of trading is not necessarily disclosed to third parties.
OTC spot markets are usually private and less regulated than the exchange landscape. Moreover, they allow traders to buy and sell larger amounts of crypto without moving the market price too much.
Peer-to-peer trading allows traders to trade cryptocurrencies among themselves. Similar to OTC, peer-to-peer trading can be carried out without the involvement of third parties or intermediaries.
P2P trading gives you more control over your trading activities like choosing sellers, buyers, settlement time, pricing, and payment methods. Most P2P platforms require buyers and sellers to create bids and offer using these preferences to enable trades to occur more smoothly.
While P2P comes with good benefits, the trading environment can be risky without third parties facilitating trades via escrow services between traders. P2P trading can also suffer from low liquidity and slow settlement time.
Similar to traditional stock exchanges and online brokerages, centralised exchanges conduct large-scale cryptocurrency transactions using the order book model to match buyers and sellers.
CEXs also provide custody services by allowing you to deposit and store your crypto assets on their platform. Through centralised exchanges, you can enjoy higher liquidity on your preferred asset, fast trading times, security, and customer protection. For providing these services, CEXs charge users transaction fees on every trade they make. Currently, CEXs are the most utilised form of accessing the crypto spot market.
Decentralised exchanges are platforms that allow you to access the spot crypto market without brokers or intermediaries. Unlike the traditional P2P method or CEXs, users typically trade against the liquidity in a type of smart contract referred to as an automated market maker (AMMs).
Users trade cryptocurrencies directly from their wallets without surrendering custody of their assets. Through decentralised exchanges, you can access the spot market without surrendering your privacy and negating counterparty risks.
Trading fees in DEXs are generally cheaper. However, when their blockchain networks become congested, transaction fees can skyrocket. DEXs can also have low liquidity and are generally not as simple to use as their centralised counterparts.
Crypto CFDs (contracts for difference) are financial derivatives that allow traders to speculate on cryptocurrency prices without taking ownership of the underlying asset.
Traders typically predict the price movements of a cryptocurrency - upward or downward - while placing a small amount of an asset value as collateral. If the trade goes in the trader’s way, the broker pays them the difference between the opening and closing prices. Conversely, if the trade moves against the trader, they book a loss and pay the difference to the broker. The profit (or loss) is calculated by multiplying the value of the change in the asset by the quantity.
One of the main differences between crypto spot trading and crypto CFDs is the ability for traders to have access to leverage. CFDs enable traders to use leverage to magnify their profits with minimal initial capital. However, while leverage increases profits, it can also magnify losses.
Crypto spot trading, on the other hand, does not have access to leverage and you can only profit from upward price movements. Crypto spot trading gives you full ownership of the asset you are trading, meaning you can utilise it for other purposes.
Unlike crypto CFDs where you are required to pay interest swap fees for holding positions overnight, spot trading allows you to hold positions for as long as you want without paying any fees.
Both crypto spot trading and crypto CFDs offer interesting ways to gain exposure to the crypto market. Your ultimate choice between both is dependent on your investment approach and strategy.
Let’s take a look at the benefits of trading cryptocurrencies in the spot market.
Crypto spot trading comes with certain risks and disadvantages. Below we outline the most important ones for you.
Margin trading is a form of trading cryptocurrencies similar to CFDs. It involves the use of borrowed funds to capitalise on future price movements. It's also referred to as trading with leverage because you can leverage up the size of your capital to potentially realise larger profits.
The borrowed funds are provided by other traders, and on some occasions, crypto exchanges or brokerages that earn interest based on the demand for margin funds.
Margin traders can open both long or short positions to reflect their predictions for upward or downward price movements. Traders are required to deposit collateral for the borrowed funds. If the market goes against their positions, their collateral can get liquidated if margin requirements are not maintained.
Spot trading is more straightforward. You take ownership of assets when you buy them, and you can't borrow or use leverage in the spot market. You only make a profit when the cryptocurrencies you purchased are rising in value, and you exit your position.
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