The first and the original cryptocurrency to be launched in 2009, Bitcoin (BTC) has become highly popular amongst traders across the world. The exponential growth in Bitcoin trading in recent years is expected to continue and may surpass that of other assets in five years. One of the most popular ways to trade Bitcoin is through Contracts for Difference or CFDs, which involves taking trade positions based on speculations regarding the future price movements of the cryptocurrency.
The reason why cryptocurrency CFD trading is popular against the actual purchase of BTC is that the former does not require the opening of a digital wallet or an account with a cryptocurrency exchange. To know more about Bitcoin CFD trading, let us first see what Bitcoin is, how CFD trading occurs and how to trade Bitcoin via CFDs.
What is Bitcoin?
Bitcoin is the first and most widely traded cryptocurrency, created in 2009 by an unknown entity, known as Satoshi Nakamoto. While initially, the digital currency was met with a lot of skepticism and termed as fraud by institutions and governments across the world, recent years have seen its acceptance as legal tender in many nations, including Australia.
The large-scale acceptance of the crypto is evident in the sharp surge in its value to nearly US$20,000 in 2017. The currency has been trading above US$9,000 for most of 2020. To understand how Bitcoin is different from fiat currencies, we need to know its features and functions.
What are the
Features of Bitcoin?
Digital: Bitcoin is a digital currency that does not exist physically. It is used and distributed electronically.
Decentralised: It is based on a decentralised peer-to-peer network, with no single institution, government or person, controlling it. The currency’s independence from world governments, banks and corporations is what makes it highly popular.
Transparent: Every transaction of Bitcoin is stored in a massive distributed public ledger, based on blockchain technology.
Limited Supply: Bitcoin cannot be printed and its overall supply is limited to 21 million coins by its creator. The supply of the crypto is managed through halving the block reward or the release of the new Bitcoins after every 4 years.
Anonymous: Bitcoin transactions are recorded in a public log, but the names of the buyers and sellers are never revealed.
Non-Reversible: Transactions in Bitcoin cannot be reversed. So, if somebody has sent Bitcoins to another person, there is no way of getting the coins back, unless the recipient is willing to return them.
Bitcoin is not regulated by a central authority, unlike fiat currencies like the US Dollar. Instead, this digital currency is backed by millions of computers, spread across the world. Bitcoins can be bought and sold via bitcoin exchanges and stored in digital wallets that exist on the cloud or a user’s computer. All these transactions are recorded in a public ledger, in the form of blocks and any change in these blocks affects all subsequent blocks. The ledger contains every transaction ever processed.
The process of solving complex computational problems or “Proof of Work” to earn a new Bitcoin is called Bitcoin mining. This process of generating new Bitcoins, after checking and verifying all the previous blocks, makes the entire network secure and trustworthy. Bitcoin miners ensure that no Bitcoin is being duplicated.
Yes. One can trade cryptocurrencies in several ways:
1. Buy Bitcoin through a cryptocurrency exchange in the hope of selling it at a profit. This requires opening an account with a crypto exchange and opening a digital wallet to store the cryptocurrency.
2. Speculate on the change in price by trading in CFDs or Contract for Difference. This option allows an investor to reap the benefits of Bitcoin trading without having to physically own the digital currency.
3. Bitcoin futures are investment vehicles that help traders protect themselves against price changes. The purchase of a futures contract involves signing a contract to purchase a cryptocurrency at a later date, at a specific price. These contracts can be settled by the actual transfer of Bitcoins to the counterparty or through a cash settlement.
What is CFD
A Contract for Difference or CFD is a contract between two parties, generally a trader and a broker, based on the change in the price of the underlying asset, which can be an index, fiat currency forex pair, stocks or cryptocurrencies, without considering the underlying value of the asset. The two parties agree to exchange the difference in the value of the asset between the time the contract is opened and the date it closes.
So, the trader gets an opportunity to speculate on an asset without actually owning the underlying asset. CFD trading is also popular as it is a leveraged product, which means that a trader needs to deposit an initial small amount, called the margin, while getting a chance to enter a much higher position. However, while leverage can magnify profits, it also multiplies losses, and should be used judiciously and you should consider whether you understand how CFDs work.
When cryptocurrency trading, a trader can either take a long or a short position while trading CFDs. Taking a long position means that the trader is expecting the value of the underlying financial asset to increase in the future. Similarly, taking a short position means selling, since the trader expects the value of the underlying financial asset to decline in the future.
What is Bitcoin
Bitcoin CFD trading means taking a position in the digital currency, depending on your prediction of the future movement in the cryptocurrency’s price. Bitcoin CFD trading allows a trader to speculate on the price of the crypto and take a long or a short position, accordingly. So, if a trader feels the price of Bitcoin will go up in the future, they open a long position, whereas, if they expect the price to decline in the future, they open a short position.
Traders can either enter into a contract, based on the performance of Bitcoin, relative to another cryptocurrency, such as Ethereum or Litecoin, or a fiat currency like the Australian Dollar or the US Dollar. Trading Bitcoin CFDs allows traders to trade without the fear of losing their funds or assets due to hacking or stealing.
At the same time, this type of trading also has its share of risks, especially since a high leverage can be involved. This is why traders prefer to chalk out a good risk management strategy and do thorough research and analysis of the market before trading Bitcoin and other cryptocurrency CFDs.
While hundreds of cryptocurrencies have emerged in recent years, only a few witness high trading volumes. Some popular cryptocurrencies for CFD trading are Bitcoin, Ethereum, Ripple, Bitcoin Cash, and Litecoin.
CFDs Preferable to
While both CFDs and futures allow Bitcoin trading, they differ on several counts:
1. Futures have a specific expiry date, which CFDs don’t. A CFD can be held for as long as the terms of the contract allow. On liquidation of a CFD contract, the difference in price is calculated and paid to the appropriate party.
2. Futures trade on large exchanges and require a higher minimum deposit. In contrast, CFDs are leveraged financial instruments that allow traders to gain higher exposure with a low margin deposit.
3. CFDs have higher spreads than futures but the fee charged by the broker in the case of former is lesser than that for futures.
4. Opening a CFD account is easier than starting futures trading. One can even open a demo account to get acquainted with the process of trading CFDs, before opening a live account.
Is Bitcoin CFD
The regulation of cryptocurrencies differs from country to country. The decentralised nature of digital currencies has made governments wary, so that they look for ways to regulate cryptos. The growing popularity of digital currencies has raised the issue of protecting vulnerable retail investors, who might have little understanding of the volatility of the crypto markets and the risks associated with trading them. While several countries have made trading Bitcoin and other cryptocurrencies legal, several others are yet to do so.
Countries like Australia have made the purchase of cryptocurrencies and the existence of exchanges legal. One of the most progressive nations, in terms of cryptocurrency acceptance, Australia not only accepts them as legal tender, but also allows them to be treated as property. Cryptocurrencies are subject to capital gains tax in Australia.
All cryptocurrency exchanges and brokers in the country have to register with the Australian Transaction Reports and Analysis Centre or AUSTRAC. All exchanges and brokers need to identify and verify their users, maintain records and comply with the government’s reporting obligations. Unregistered exchanges are subject to criminal charges and financial penalties.
So, do check the legality of trading Bitcoin CFDs in your country before you start. Also, the changes in regulatory frameworks for Bitcoin and other cryptos can drive future price movements of these currencies. So, staying abreast of the latest developments in the market is crucial for crypto CFD traders.
Since the very nature of cryptocurrencies differs from fiat currencies, the factors that influence their prices also differ. While traditional currencies are affected by economic and political news, Bitcoin and other cryptos are largely driven by the demand and supply for them, as well as any updates on their regulation. Some major factors that influence Bitcoin CFD trading are:
Supply and Demand
While cryptocurrencies like Bitcoin are witnessing strong demand, the supply for them is limited. This affects their prices, leading to constant fluctuations. The change in demand is a major factor affecting the price of Bitcoin and other cryptocurrencies. The supply of Bitcoin is dependent on the rate of creation of new Bitcoin, which slows down every four years. In this scenario, when the demand for Bitcoin increases at a faster rate than the increase in its supply, the price is bound to go up. Another factor that affects the price of Bitcoin is that its total availability is capped at 21 million, with no further mining allowed once this level is achieved.
Since the cryptocurrency market is largely unregulated, any update or regulation can lead to a significant change in the prices of digital currencies. The regulation could be in the form of prohibition of digital currency or its recognition as legal tender or allowance of its use in specific places.
News About New Offerings or New
Any news relating to the launch of new cryptocurrencies or their forks and their listing can affect the prices of the existing coins.
Reports of Hacking
The cryptocurrency world is prone to hacks and fraudulent activities. So, any news related to the hacking of crypto coins or exchanges can lead to a decline in the prices of digital currencies.
Any news about setting up of additional infrastructures, such as ATMs or acceptance of Bitcoin by additional businesses, acts as a booster and leads to an increase in prices.
How does Bitcoin
CFD Trading Work?
CFDs for Bitcoin and other cryptocurrencies are derivative financial products that enable traders to speculate on the rise and fall in the price of the concerned digital currency, without needing to own the currency. Here are some features of CFD trading in cryptocurrencies:
Leveraging: CFDs are leveraged products, which mean a trader can open a position for a fraction of the total value of the trade. Although leveraging magnifies one’s profits, it also increases losses, in case the market moves against your prediction. So, one should use leverage judiciously.
Margin amount: Traders need to deposit a minimum amount, called margin, in their accounts. The margin amount depends on the level of leverage. The margin requirement changes as the position of your trade changes. For instance, a broker may have a margin requirement of 20%. In this case, if you take a position worth $5,000, you need to deposit $1,000 as the margin amount.
Spreads: Spread is a difference between the ask and bid prices for a cryptocurrency. Remember to check the latest spreads to make informed trading decisions.
Lots: Cryptocurrencies are often traded in batches or lots to standardise position sizes. Since cryptocurrencies are highly volatile, their lots tend to be very small.
Go Long: A trader can open a buy position on a CFD in anticipation of an increase in the price of the underlying crypto. This is called going long.
Go Short: A trader can open a sell position via a CFD when they anticipate that the price of the underlying crypto will decline in the future.
Stop Loss: This risk management tool allows traders to set a predetermined price level at which their CFD position will be closed. This tool helps in minimising losses, if the market moves against the predicted direction.
Take Profit: This tool calls for setting the price level at which a trader’s position is closed, to allow profits to be locked in before the market moves against the predicted level.
What are the Pros
and Cons of Bitcoin
There are numerous advantages to trading Bitcoin as a contract for difference. Some of the benefits of trading Bitcoin CFDs are:
Leveraging allows traders to take positions much large than they can afford with their own capital. This enhances the potential gains that a trader can earn.
Bitcoin CFD trading does not involve the actual purchase of the digital currency, doing away with the need to keep them safe in a digital wallet.
It offers traders a chance to speculate on the change in price, both ways. So, a trader can trade CFDs in both rising and falling markets.
Investment in Bitcoin CFDs is simple and can be done vis-à-vis fiat currencies, such as the USD or AUD, or against another digital currency.
Brokers offering CFD trading are regulated and need to follow set rules and regulations to ensure the safety of client funds.
CFD trading is done through brokers, who offer customer support services to their clients, to ensure that the latter have satisfying trading experiences and stay on with them.
Although trading CFDs is risky, use of risk management tools, such as stop loss or take profit orders, allows one to minimise risk.
However, there are several disadvantages associated with trading Bitcoin CFDs. Let us look at them:
Leveraging or margin trading can lead to significantly higher losses.
The cryptocurrency markets are highly volatile resulting in several intra-day changes, which often make it difficult to make the right predictions about future price movements.
Bitcoin CFDs are speculative in nature and could lead to high losses.
How to Trade
Once you have decided to trade Bitcoin CFDs and are aware of its benefits and risks, you can go ahead and choose a trusted and reputable broker, registered with the regulatory authorities and compliant with regulations.
1. Finalise a Broker
Apart from checking the reputation and ensuring that the chosen broker is a regulated entity, one needs to find out:
About the leverage being offered and the margin amount required. This is important because this will decide how much exposure one will get and what positions can be taken.
Check the product options. While Bitcoin CFDs are offered by most brokers, due to its leading position in the sector, several other crypto CFDs are also traded.
About the trading platform being used. MetaTrader 4 and MetaTrader 5 are highly user-friendly platforms and come with inbuilt tools and resources that aid in CFD trading in a wide variety of asset classes, including trading cryptocurrencies.
The spreads, commissions and fees being charged to determine the cost of trading cryptocurrency.
The broker’s customer support services and additional resources offered to aid in trading.
Payment options and the terms of payment for depositing into and withdrawing from your trading account.
2. Open a Bitcoin CFD Account
Once the broker is finalised, the next step is to open an account with the chosen CFD broker. You can try a demo account first to get hands-on experience and then follow it up with a live account. Before you actually start trading, you need to deposit the initial margin amount. Choose your level of leverage, depending on your risk appetite and your available funds for trading. You also need to decide which cryptocurrencies to trade in.
3. Build a Trading Plan
Now that you are ready with your account, choose the cryptocurrency you wish to trade and finalised the leverage level, you need to build a trading plan. This should be based on a good amount of research about the market for the chosen cryptocurrency, its price movements, factors that are likely to drive its future movements and your predictions and goals. Do not forget to take into account the amount of funds available to you and your risk appetite.
4. Take a Position
The next step is to open a position on the basis of your price movement analysis. You can either go long or short, depending on how you expect the price of the underlying cryptocurrency to move in the future. Also, remember to set stop loss and take profit levels to limit your losses, in case the market moves in an adverse direction.
5. Monitor the Position
When trading Bitcoin CFDs or cryptocurrency CFD trading in general, one needs to ensure that the margin amount in the trading account does not fall below the minimum limit. This helps you avoid unwanted and untimely closure of your position by the broker, due to lack of funds. Continuous tracking of your account and price movements enables swift action.
Once again, remember that trading CFDs entail risk due to high leveraging and the highly volatile nature of the cryptocurrency market. So, stay updated, constantly monitor your positions and make use of risk management tools for a satisfying trading experience.
Source - database | Page ID - 951