A Beginner’s Guide to Crypto Trading – Part 2: Understanding Cryptocurrencies

By
Hernaldo Turrillo
A Beginner’s Guide to Crypto Trading – Part 2: Understanding Cryptocurrencies

A Beginner’s Guide to Crypto Trading is 4 part guide covering all you need to know about crypto trading.  In this second part, we focus on the cryptocurrencies and their risks/traits, tipping out some basic knowledge to be aware of, when trading cryptocurrencies.

Cryptocurrencies have become mainstream for a reason and that is the plenty of possibilities they can be applied for. They are no just an investment product, although they can act as one, neither a common currency due to their own digital nature. Instead, they are all of them at once and even more.

As we stated in the Part 1 of this beginner’s guide to Crypto Trading, understanding their own characteristics will make the difference between choosing the right one or doing a misstep in any crypto-trading adventure. For that, there are a few questions that need to be answered as though cryptocurrencies are all based on blockchain technology, they are not all created equal.

2. Cryptocurrency’s characteristics

In fact, When it comes to cryptocurrency trading, there are four traits one should be looking at:

1) Liquidity: The ability for holders to cash out via exchanges and marketplaces.
2) Transactability: A factor of cryptocurrency’s default block mining time. The higher it takes time for a new block to appear, more difficult it is to use in everyday transactions, e.g. shopping for coffee, buying t-shirts, domain names, etc.
3) Anonymity: Whether public eyes can see what’s going on in the ledger, who is buying what, who is selling, etc. In contrast to popular opinion, most cryptocurrencies are not anonymous.
4) Programmability: The ability to develop trustless contracts on top of the public ledger. This is a state-of-the-art advanced concept introduced by Ethereum, which you can skip.

And here are some differences that you need to understand to make informed trading decisions, as shown by expert crypto-trader Hugh Kimura:

  • Transaction processing speed
  • Total supply currently available
  • Will there ultimately be a limit on the total number of currency available?
  • Will there be an unlimited supply of currency?
  • Is there a real-world need for this software/currency?
  • Real world adoption of the technology
  • Any big investors in the project?
  • Does the use of the software make sense?
  • Do the founders have a reputable background?

Most of these questions can be looked up through search engines. Furthermore, most of the exchanges provide information which might result vital in our success.

However, these are just a few of the characteristics that you should look at. But once you start digging into these details, you will begin to see which projects could work for their intended purpose and which ones are probably scams.

This understanding will also allow you to assess the long-term viability of these different currencies and which ones will be more desirable in the future.

Here is an example:

“Tether is a cryptocurrency that wants to be the proxy for fiat currencies. So there is a Tether USD version, EUR version, etc. But each one is pegged to the value of the currency, so you can never make any money trading it.

It is purely to provide stable and liquid transactions. So one USD Tether will always be worth about $1.”

If you didn’t know this and bought a bunch of it, thinking that it’s cheap compared to Bitcoin, you will tie up your money in an asset that will never appreciate. Sure, you won’t lose money either, but you would have lost out on other opportunities.

2.1 Risks of cryptocurrencies

Trading on cryptocurrencies might be tricky as it is a market open 24/7 worldwide. All transactions are done in real time at any time. That actually takes us to the first risk when speaking of cryptocurrencies: volatility.

This volatility can make investors to run away in the beginning but it actually represents an amazing opportunity if we are able to understand what is behind all of it.

In fact, veteran cryptocurrency investors know this to be a fact, but exactly why is this asset class more volatile than any other liquid asset in the market? Following expert Arthur Iinuma, we can find 6 inherent risks:

1. No intrinsic value

Despite company sized valuations, cryptocurrencies don’t sell a product, earn revenue or employ thousands of people. They generally don’t return dividends, and just a tiny amount of the total value of the currency goes into evolving it. Because of this, it is hard to value. How do we know if it is overbought or oversold? When is it a good value or overpriced? 

2. Lack of regulatory oversight

Cryptocurrency is a worldwide phenomenon, and while governments are clamping down on the industry, regulation is still in its early days. Such limited regulation allows for market manipulation which, in turn, introduces volatility, and discourages institutional investment.

3. Lack of institutional capital

While it is undeniable that some pretty impressive venture capital companies, hedge funds and high net-worth individuals are both fans of and investors in crypto, as a segment, most of the institutional capital is still on the sidelines. Most banking heads admit that there’s some validity in the space, but have yet to commit significant capital or participation publicly. Institutional capital comes in a variety of forms, such as a large trading desk that has the potential to introduce efficiency and soften market volatility.

4.Thin order books

Crypto investors are taught to never keep coins on an exchange, which can be hacked. As a result, most of the tradable supply is not on an exchange order book but in off-exchange wallets. In contrast, nearly all of the tradable stock of a publicly listed company is transacted on a single exchange. A large market order can eat into an exchanges order book on the way up or down, causing something called “slippage.” Because of the capacity for large traders to move the market in either direction and employ tactics to encourage this, volatility goes up.

5. Long term vs. short term

Cryptocurrencies, for the most part, can’t be bought in retirement accounts, and are generally inaccessible to retail brokers and financial advisors, so an entire ecosystem of investors is left out. This leaves us with early adopters that are comfortable with the technology hurdle of dealing with wallets, and web-based trading platforms.

6. Herd mentality

Crypto is largely a phenomenon of millennials, who distrust government, are early adopters in tech, and have been mainly shunned out of investment wins earned in the last decade of rising real estate and stock market prices. But most millennials do not have the long-term investment experience of their more mature generational counterparts. They also tend to have less disposable income as a result of historically poor job economics, and less time in the workforce. This combination of factors results in a few things; an appetite for risk in the hopes of landing a windfall of cash and utilizing a larger share of whatever capital they have to invest in risky instruments, including purchasing such investments on credit.

2.2 Cryptocurrency cases: Bitcoin, Ethereum and Altcoins

Almost every currency software has a different intended purpose and individual implementation, with inherent strengths and weaknesses. Bitcoin for instance is the strongest one and most traded and it has being defined by investors as “digital gold” for its finite amount. It has opened the way to hundreds of new cryptocurrencies.

On the other hand, Ethereum and its smart contract capability have changed the role of how some cryptocurrencies can be used not just as digital money but as an financial product.

Here are a few examples of the different types of cryptocurrencies and what they are designed to do:

Worldwide Financial Transactions

Application Platforms

Private Financial Transactions

Specialty Currencies

Click here for a full cryptocurrencies list.

Take a look at these different use cases and figure out which ones make the most sense to you. Then understand how each software implementation works and think about what will probably do well in the future.

Knowing the risks will get us ready for any inconvenience we can find when trading cryptocurrencies. And despite the volatility, the potentials on this new type of digital money are huge, as many investors have embraced them to be the next digital revolution.

In the next part we will focus on the market-plaza where cryptocurrencies can be trade at. We will see how these exchange provide everything we need to to start our trading fortune, from the digital wallets we need to set up to save all our cryptocurrencies to the differences between them in terms of withdrawals or coin assets portfolio.

Part 4 can be found here.

Part 3 can be found here.

Part 1 can be found here.

RELATED ARTICLESMORE FROM AUTHOR