A Beginner’s Guide To Trading Cryptocurrencies

In Summary: 

• The crypto market has exploded in popularity over the last decade
• Cryptocurrencies are just one element of the Decentralized Finance and blockchain movements

Cryptocurrencies are the newest, boldest, craziest breed of assets to enter the markets. As part of the wider DeFi (Decentralized Finance) movement, cryptos have revolutionized our concepts of ownership, investment, and exchange within an exciting digital realm. As if proof was needed of the soaring popularity of cryptos, 2021 saw the total market capitalization top a whopping $3 trillion and as of 2022, over 12,000 crypto coins are available to trade. But where do you start in this new, digital world of trading? How does it all work? And moreover, why trade cryptos at all? 

What Is Cryptocurrency? 

At its most basic, a cryptocurrency is a digital currency that operates via a decentralized system called blockchain. The blockchain is effectively a huge global network that allow P2P (peer-to-peer) transactions without the need for an intermediary institution or server. 

Traditional (fiat) currencies, such as dollars, sterling, or euros, are issued and controlled by central banks. In contrast, cryptocurrencies (generally) exist independently of fiat systems, so they are considered less prone to governmental manipulation or interference. 

For traders, cryptocurrencies offer interesting opportunities to find exposure outside of the conventional financial markets. Digital currencies are valued for being highly speculative compared to other assets and it is exciting to immerse yourself in an industry that pushes the boundaries of convention. But the crypto sphere is also extremely turbulent and not for the faint-hearted! 

What Defines Cryptocurrency? 

1. Decentralized: Unlike fiat currencies, cryptos have no central bank or authority. Instead, an open and distributed network on the blockchain processes and verifies all transactions. 
2. Permissionless: Like the internet, crypto is designed to be universally accessible, regardless of the background, location, or credit history of users. For remote or unbanked populations, crypto offers unprecedented financial opportunity. 
3. Trustless: Because the blockchain delegates crypto verification processes, transaction processing is neutral and there is no intermediary interference. 
4. Transparent: The global distribution of the blockchain keeps transactions secure and traceable.
5. Censorship Resistant: Thanks to the structure of the blockchain, the record of crypto transactions is safe from localized tampering or censorship.
6. Programmable: In general, the cryptosphere is still in a highly experimental stage. This means that individual cryptocurrencies and their respective blockchains are undergoing constant technological evolution to become more efficient or specialized in their purposes. Where central banks control the strength of fiat currencies, it is the decentralized network of programmers and users that influence crypto development. 

Blockchain Basics 

As already mentioned, blockchain is the technology that underpins cryptocurrencies. Essentially, it is a universal ledger that encompasses a network of highly-powerful computers.  

In terms of cryptocurrencies, the blockchain records and verifies all transactions. It does this by delegating complex mathematical problems between component computers, or nodes, to solve. This creates what is called a consensus mechanism and is what we mean when we describe blockchain as ‘trustless’. Anyone with internet access can view the blockchain’s record of transactions, so everything is completely transparent. 

The most common consensus mechanism is Proof-of-Work, or ‘mining’. The miners are the nodes that complete the verification of transactions, and they receive rewards for their work in the form of more crypto. Once verification is complete, the transaction enters the ‘chain’ as part of a ‘block’. Over time, more and more blocks stack into the chain, so whilst transactions can be reviewed, they can never be altered or removed.

Crypto transactions are far more efficient and direct than making conventional payments through a bank. This cuts waiting times to hours or minutes even on large exchanges, and the only cost incurred is the nominal fee for the miners’ rewards. 

Bitcoin is an example of a cryptocurrency whose supply depends on mining. Supply increases as miners complete each block, so more crypto enters circulation. The overall supply is capped in order to control inflation and drive up demand; Bitcoin, for example, has a total possible supply of $21 million, and mining will finish by 2140. 

The Pros Of Trading Cryptocurrencies 

By now it should be apparent why cryptocurrencies have exploded in popularity in the past decade. But cryptocurrencies, like fiat currencies, are also tradeable assets, and offer specific trading perks and pitfalls. Reasons to trade crypto include: 

• Market hours: Crypto can be traded 24/7, unlike conventional financial markets. 
• High volatility: The constant speculation, innovation, and change around the cryptosphere produces frequent and dramatic price movements. This makes digital assets ideal for scalpers and short-term trend traders to make fast profits. 
• Long-Term Growth: If crypto is still in its early days, traders can look forward to long-term growth with more institutional adoption and application. 
• Go Long Or Short: Thanks to derivative trading, it is even possible to go long or go short on crypto assets and profit from price changes without holding the crypto itself.  
• Hedging: Fiat currencies are prone to inflation or devaluation, but cryptos benefit from the independence of their decentralized system. Because of this, traders can use cryptos to hedge against other positions in fiat or equity markets. 
• Innovation: Traders gain exposure to blockchain development in both the financial realm and beyond.  
• Choice of Assets: A vast array of different crypto projects are on offer for traders to diversify their exposure. 

The Cons Of Trading Cryptocurrencies 

On the other hand, cryptocurrencies are notorious for spectacular market thrills and spills. Pitfalls to be aware of include: 

• Unstable Liquidity: Liquidity describes the potential for assets to be converted to cash without affecting market price. The most prominent cryptos, such as Bitcoin and Ethereum, enjoy better liquidity than thousands of lesser-well known coins. In general, however, crypto offers lower liquidity than major fiat assets. This means that a whale (large-volume holder of crypto) can dramatically influence prices with a single transaction. 
• Volatility risk: High volatility offers great opportunity, but also significant risk. Sudden price reversals and enormous drops can catch traders out. 
• Choice of Assets: With thousands of cryptos to choose from, it can be hard to pick the winners from the losers, especially in such a nascent industry. 
• Uncertainty: The world is still figuring out how to deal with or regulate crypto, and pessimists point to the Dot-com bubble of the late 1990s as proof that exponential growth is unlikely.   

Summary 

Digital currencies have revolutionized fintech potential and opened an exciting, constantly-evolving niche in the financial markets. Traders should appreciate the significance of the blockchain technology because it is the driving force for future growth and opportunity. In terms of trading, cryptos, like any other asset, carry specific risks, but also offer unique opportunities for diversification.  

Are you a crypto newbie, or looking to add crypto to your trading portfolio? Check out our next article for some expert tips to bulletproof your crypto trading strategy.