- A cryptocurrency is a virtual currency that is secured by cryptography.
- Cryptocurrencies can be traded in pairs, in a similar manner as ‘traditional’ currencies.
- Cryptocurrency is denominated in terms of digital ‘tokens’ kept in a system made up of a network of computers called a blockchain.
- Tokens are kept in wallets that can be hot (digital) or cold (physical), and traders can choose to keep their tokens in either or both wallets.
- Traders have a higher level of privacy as crypto trading is semi-anonymous.
What exactly is cryptocurrency?
Cryptocurrency, also commonly known as ‘crypto’, is a virtual currency that is secured by cryptography. Traded and stored with blockchain technology, cryptocurrency is denominated in terms of digital ‘tokens’ kept in a system made up of a network of computers. These virtual currencies are encrypted by algorithms and cryptographic techniques to ensure security. Trading involves complex transactions that require public and private keys, proof of work, proof of stake, elliptical curve encryption, and more. As trading takes place electronically, traders can retain their privacy and ensure integrity in transactions, preventing the counterfeit or double-spending of tokens. Unlike ‘traditional’ currencies in forex trading, cryptocurrencies are not issued by any central authority, such as banks or monetary authorities, that are associated with the local government. This means that governmental interference with the cryptocurrency market is highly unlikely.
How does cryptocurrency work?
Cryptocurrency can be bought and kept as an investment or traded as part of a pair. Both options follow the same concept as the speculation of price movements of other assets such as forex, stocks, and more. Traders go long on a cryptocurrency when they anticipate an appreciation of its value and sell when the trader anticipates its depreciation.
Where cryptocurrencies are stored
Cryptocurrency can be stored, sent, and received in a cryptocurrency wallet. Also known as a ‘crypto wallet’, it stores tokens and keeps track of several things. These include public and private keys, which are used to authorise currency transactions. Cryptocurrency wallets are essential for participation in trading. When a trader wants to buy or sell currency, they access their wallet. There are two main types of cryptocurrency wallets, and they are hot and cold wallets. Hot wallets are digital, while cold wallets come in a physical form.
Hot wallets
Hot wallets, also known as software wallets, are further divided into three types. They are web wallets, desktop wallets, and mobile wallets. They are accessed exactly as their names suggest. Web wallets are accessed through a web browser, desktop wallets are accessed through an application downloaded onto a computer, and mobile wallets are accessed through a mobile application. Someone who is always on the go may prefer a hot wallet so they can trade anywhere from their mobile device or tablet.
Cold wallets
On the other hand, cold wallets come in hardware and paper wallets, and they do not require Internet connectivity to be accessed. Hardware wallets may come in the form of flash drives and other special ledger devices, while paper wallets are physical paper documents that contain all of a crypto trader’s data. As cold wallets are not connected to the Internet, it is perfect for traders who prefer a higher level of security.
Types of cryptocurrencies
Undoubtedly, Bitcoin comes to most traders’ minds when cryptocurrencies are mentioned. The first blockchain-based currency, Bitcoin, was launched in 2009 by an unknown entity under the pseudonym Satoshi Nakamoto, and it remains one of the most popular and valuable cryptocurrencies today. However, thousands of other cryptocurrencies have joined the market since Bitcoin’s conception. Amongst them, some were built entirely from scratch, while others are clones or forks of Bitcoin. In the market are also alternative currencies that were spawned from Bitcoin’s success. Categorised as ‘altcoins’, these currencies include Litecoin, Namecoin, Peercoin, and Ethereum, to name a few. Each cryptocurrency has its own function, and trading specifications, including the degree of anonymity traders can be afforded. Although cryptocurrency trading is semi-anonymous to begin with, this also offers a level of flexibility for traders who may want more privacy when trading.
How is cryptocurrency traded?
Cryptocurrency pairs
Much like forex trading, cryptocurrencies are traded in pairs, and each pair contains a base currency (the one shown on the left) and a quote currency (the one shown on the right). Pairs can either be formed between a cryptocurrency and a ‘traditional’ currency or between two cryptocurrencies. Here at Rakuten Securities Australia, we offer BTC/USD
The cryptocurrency market
Much like the forex market, the cryptocurrency market is not centralised, meaning that it is not owned by any one individual or entity. The cryptocurrency market runs across a network of computers, and tokens can be bought and sold and stored in wallets.
Benefits of trading cryptocurrencies
Trading is more flexible
Like most assets, cryptocurrencies can be bought as an investment or traded in pairs, giving users a higher degree of flexibility. When trading, there is the option to go both long and short, allowing traders to participate in both bullish and bearish markets in the attempt to make a profit.
Funds more easily transferred
Cryptocurrency pairs can be traded between two parties directly instead of having to employ the assistance of a trusted third party such as a bank, a broker, or any other financial institution. With the middleman eliminated, the process is streamlined and made more convenient, and transaction costs can also be lowered.
More people can participate
As cryptocurrency pairs can be traded between two parties directly, more people can participate in this exchange. This is especially beneficial for residents without access to advanced financial institutions and infrastructures.
Higher levels of privacy
Due to the semi-anonymous nature of trading cryptocurrency, where tokens are kept in individual wallets instead of with broker or bank accounts, crypto traders can enjoy a higher level of privacy than those who trade traditionally. A higher privacy level also brings better protection for traders who reside in countries that are politically unstable or have oppressive governments.
Cryptocurrency trading considerations
Despite the numerous benefits of trading cryptocurrencies compared to traditional currencies or other assets such as stocks, metals, and more, there are also considerations traders have to keep in mind.
High volatility
As the price movements of cryptocurrencies depend entirely on market participants who trade according to rapid news cycles, their transactions end up moving the market at a swift pace. In recent history, price charts have shown cryptocurrencies’ ability to skyrocket and plummet, which is why crypto traders should definitely exercise caution.
Low liquidity
The cryptocurrency market is relatively new and considerably less established than most assets in mainstream markets. For some cryptocurrencies, their newness also means they lack an established ecosystem of speculators and investors. This translates to a lack of liquidity in the market, making trading difficult.
Possibility of illegal activity
There is also a flip side to the higher level of anonymity offered by cryptocurrency trading. Namely, that it becomes easier for traders to participate in illegal activity. This can include tax evasion and money laundering. Scams are more easily run as well.
What is the best cryptocurrency to invest in?
Like all trading and investing endeavours, the market constantly fluctuates depending on the time of day, and there can be no guarantee of making a profit on trades. Additionally, traders should keep in mind that each cryptocurrency is different and provides different levels of benefits and risks. Thus, it all depends on individual needs and interests and the level of risk each trader is willing to run. The bottom line A cryptocurrency is a form of digital or virtual currency that is secured by cryptography. It is stored and transacted within a secure and distributed digital ledger. Like ‘traditional’ currencies, cryptocurrencies can be bought as an investment or traded with the aim to make a profit. Here at Rakuten Securities Australia, we offer BTC/USD (Bitcoin/US dollar) trading on our sophisticated MetaTrader 4 platform. Open a free demo account today to familiarise yourself with various trading strategies before trading live.