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Trading Tools Are Making Crypto More Legitimate & Predictable
Cryptocurrency has long had the association of being counter-cultural, libertarian, and even illicit. But all that is beginning to change. 2016 and 2017 were the years where blockchain and crypto entered the public vernacular. Most people you talk to these days have heard of Bitcoin and likely know something about blockchain technology. No longer is cryptocurrency a niche pursuit, millions of investors, users, and hodlers around the world are participating in this diverse and growing ecosystem.
As crypto grows in legitimacy, so too do the tools surrounding crypto. In the early days, the only trading tools available to investors were basic fiat to Bitcoin gateways. Over time, exchanges and multicurrency platforms emerged. Eventually, crypto-only exchanges came to dominate the trading market. With each of these changes, investors got more savvy and looked for more complex ways to trade and speculate on future value.
Many of these implements for speculation and investing already exist in the traditional banking world. Funds, options, futures, margin trading, and algorithms have all made their way into crypto as the market has matured and shown itself capable of bearing new trading patterns. This article will cover all the new trading implements that have come to crypto, how they’re affecting exchanges, and what to expect in the near future.
2017 was the year for funds in cryptocurrency. According to Bloomberg more than 150 different crypto funds began last year at the height of the bull market. Many of these funds posted enormous profits as the market climbed higher. However, when the correction of early 2018 came, many funds felt the crunch. Both demand and profits for funds have dried up this year, but the top funds are still doing well. They manage their downside while capitalizing on volatility in the market.
A new trend for this year and coming years is the fund of funds model. Essentially, these investments buy shares in many different funds to further diversify holdings and trading patterns. Still, hedge funds and funds of funds are actively traded and managed portfolios. Making money from investing in a hedge fund means beating the market enough to warrant the high management fees.
One area that deserves further exploration and more attention is low-fee ETFs and index fund cryptocurrency trading. These passively managed investments diversify across many assets based on an index. For example, a top 100 fund could invest in the top 100 cryptocurrencies by market cap and rebalance its positions at a regular interval as coins move up and down the list. This would offer ordinary investors cheap, automated options for getting money into crypto in a diversified way.
2. Options & Futures
Options and futures are similar financial implements. They both give traders the opportunity to place bets on the future value of a given token. The options and futures markets can actually have a calming effect on volatile markets if issued correctly, because you can now place bets that the market will decline as well, effectively incentivizing market skepticism.
While they both involve making bets, options and futures are slightly different. An option gives the investor the right, but not the obligation, to purchase a given asset at a given price at a given time in the future. In exchange for this option, the option provider charges an upfront fee. In contrast, a futures contract obligates investors to buy or sell an asset at a given time. Aside from commissions, futures contracts have no upfront cost, but they’re riskier bets because the investor is obligated to buy/sell and futures contracts generally require a larger underlying position (more to lose/gain). However, an obligation to buy/sell a futures position can always be settled before the last trading day.
Premiums on Bitcoin options are currently quite high, thanks to Bitcoin’s volatility. Other options for different cryptocurrencies are making their way to the markets. In the same vein, the terms of Bitcoin futures contracts favor the contract writer and require big, bold, correct bets in order to pay off. In 2017, the U.S. Commodity Futures Trading Commission approved Bitcoin futures on two major traditional exchanges in the United States, the Chicago Mercantile Exchange and the Chicago Board Options Exchange. This means that Bitcoin futures will be available to traditional institutional investors in the U.S. without them having to buy and sell Bitcoin directly.
3. Margin Trading
Margin trading is another form of bet on the future price of an asset. This time, however, the investor borrows money from the broker at a set interest rate in order to extend the amount of the asset they can sell. Margin trades can either be long or short. Long trades believe the value of the asset will increase while short trades expect the value to decline.
Either way, most margin trading happens on a short timeline. In order to make a profit investors have to make more from the investment than they pay in interest to the lender. Holding a margins contract for a long time means the interest is constantly increasing, thereby increasing the amount of return the investment needs to produce in order to outstrip the interest payment.
In cryptocurrency, several exchanges have started to support margin trading. It can be very lucrative for the lender any time an investor guesses wrong. For investors, margin trading is highly profitable when you guess correctly. However, wrong guesses and holding a margins contract for longer have nearly unlimited downside since they’re based on interest owed to the lender.
Another investment tool making a big entry into cryptocurrency is stablecoins. These investments promise not to be volatile and provide a safe place to keep your funds without having to withdraw from the cryptocurrency system entirely.
Tether, the most popular stablecoin, issues its digital token at a one-to-one ratio with U.S. dollars stored in a bank account. Those tokens are individually backed by the dollars behind them, meaning the value mirrors the dollar. However, critics point out that this solution requires a central authority and trust in Tether that the USDT tokens really are securely backed.
Other solutions involve backing a stablecoin with other cryptocurrencies, like Bitcoin. To fight volatility, these tokens are usually over-collateralized with backing Bitcoins so that the coordinating institution or smart contract can add/subtract collateral at will to keep the price stable.
Stability has been a major sticking point for enterprises and institutions interested in cryptocurrency. Stablecoins are a promising step in the right direction to making cryptocurrency more practical for everyday use.
5. Algorithm & High-Frequency Trading
Computers order and execute a high proportion of the trading on modern stock exchanges. Traders rely on scripted algorithms to tell computers exactly what to look for and when to execute trades. The same has begun to apply in crypto. Most major exchanges now have APIs that allow traders to write their own algorithms. There’s a lot of money to be made in market inefficiency and arbitrage between exchanges.
High-frequency trading of micro-transactions is widespread in the traditional stock market, but it hasn’t yet made it to crypto. The problem is that crypto exchange APIs still have slow responses and high latency that make it difficult to do anything quickly or with high frequency. However, expect algorithms and faster trading to increasingly play a role in the cryptocurrency landscape.
Cryptocurrency is taking on many of the trappings, tools, and capabilities of traditional equities markets. As it does, investing in Bitcoin and other tokens becomes an increasingly legitimate opportunity for businesses and institutional investors. Expect these tools to mature and become even more widespread over the coming years.