What is Cryptocurrency Trading and How Does It Work?

Cryptocurrency—crypto for short—is a digital currency that enables peer-to-peer transactions for goods and services without the involvement of a third party like a bank or governing body. For this reason, cryptocurrencies are referred to as decentralized finance—DeFi for short—and live on a native blockchain such as Ethereum and the cryptocurrency ether. This step away from fiat currency has grown in popularity over the years, and many mainstream payment processors account for cryptocurrency payments now. Cryptocurrencies exist on a blockchain, which is a public ledger where all crypto transactions are recorded and verified.

TYPES OF CRYPTOCURRENCIES

Within the cryptocurrency realm, there are thousands of variations. With that said, there are a handful of categories that stand out:

• Bitcoin: Bitcoin dominates the crypto market in overall adoption and price, and it is seen in the same light as the S&P 500 is in terms of being a market benchmark. When price fluctuations happen in the crypto markets, traders and investors typically look to bitcoin for an update.


• Ether: Ether is the cryptocurrency that lives on the Ethereum blockchain. Many view bitcoin as the hardware blockchain, whereas Ethereum is the software blockchain. DeFi started on the Ethereum blockchain with smart contracts.


• Altcoins: Altcoins refer to cryptocurrencies that are essentially alternatives to bitcoin. This was a generalization early on and accounted for many alternative spin-offs of the digital currency idea.


• Tokens: Crypto tokens are built on an existing blockchain rather than a cryptocurrency that has its own blockchain like Ethereum and ether. Tokens are offered as payment for transactions that take place within a blockchain ecosystem. For example, Ethereum is the blockchain, ether is the native currency of the blockchain, and ERC-20 fungible tokens and ERC-721 nonfungible tokens (NFTs) exist within the ETH ecosystem.


• Stablecoins: Stablecoins are designed to maintain a stable price and have less volatility than other cryptocurrencies. Stablecoins are designed to be tied to another asset such as precious metals or fiat currency. Since these coins are backed by something else, volatility could be lower than other cryptocurrencies. So far, there has not been a stablecoin that really stands out as having low volatility, as most of the crypto market is volatile due to the adolescent nature of the space.


• Meme Coins: Meme coins originated when cryptocurrencies took a humorous turn with ridiculous naming conventions. That fueled a craze that gave these coins legitimate explosive value, even if it was short-lived. Some of the most volatile cryptocurrencies to this day have been meme coins, and they continue to be created year after year.

HOW MANY CRYPTOCURRENCIES ARE THERE?

It’s hard to say exactly how many cryptocurrencies exist today. Many were created and failed to gain active users. With that said, there are certainly thousands of cryptocurrencies that are active and exist today. Some say there are over 9,000 active currencies as of 2024. As the space grows, more currencies will be created. It’s just a matter of whether they gain traction and maintain active users.

Traders and investors look to cryptocurrencies for a more volatile exposure to markets. This brand-new sector appeals to many levels of traders. With so many different products available to trade and invest in, cryptocurrencies are frequently in the spotlight. Bitcoin specifically has an embedded supply shortage. Over time, only 21 million bitcoins can be mined. If demand continues to increase, this can create upward pressure on the price of each bitcoin, like how Gold or Silver have a perceived floor of value. These aspects that exist in the crypto markets differ from traditional fiat currencies, which intrigues many traders and investors.

Cryptocurrency trading is no different than equity trading in the sense that the goal is to buy crypto for a lower amount and sell it for a higher amount to make a profit. Crypto trading is typically more volatile than other more established trading vehicles simply because the sector is so new and there are a lot of unknown variables in the space. To trade cryptocurrencies, consider the following steps:

1. Open a brokerage account, or open a crypto wallet.
2. Once the account is opened, fund the account for your crypto purchase.
3. Explore different cryptocurrencies and develop an understanding of risk involved in trading crypto products.
4. Once you’ve selected your cryptocurrency for purchase, develop a trading plan for profit targets and exit points, and monitor the position.

MOST POPULAR CRYPTO PAIRS FOR TRADING

Pairs trading consists of buying or selling two different assets to trade the relationship they have with one another. Bitcoin (BTC) and ether (ETH) are two very popular cryptocurrencies that tend to have a positive price correlation. This just means that often, the price of each currency moves in the same direction.

However, there are times when this is not the case. If the price of bitcoin futures is falling, and the price of ether futures is rising, a pairs trader might take a bullish stance on bitcoin futures and a bearish stance on ether futures. The idea is that the relationship could fall back into place, where bitcoin futures prices would rise, and ether futures prices would fall. If that happens, the trade would be profitable. If it does not, and the relationship continues to diverge, the pairs trader would see losses.

In any case, pairs trading typically requires liquid markets with popular products and a strong relationship in historical price movement between two assets. Pairs traders then place bets on diverging and converging relationships as time goes on.

Popular pairs trades in the cryptocurrency space may include:

• BTC/ETH
• BTC/USD
• ETH/USD

CRYPTOCURRENCY TRADING EXAMPLE

Cryptocurrency trading is like stock trading in the sense that you are buying an asset that you want to appreciate in price to make a profit. Let’s say a trader is bullish bitcoin, but only if it retreats to $55,000. It’s currently trading at $62,000. After a few weeks, the trader gets their wish, and the price of Bitcoin drops to $55,000.

They decide to buy a half of a bitcoin for a total notional value of $27,500. A few days later, bitcoin rallies back to $60,000 and they decide to close the trade to secure a profit. They sell their half bitcoin stake back to the market for $60,000, netting a profit of $2,500. The full coin’s value appreciated by $5,000. They only owned half of a coin, so their profit is $2,500.

In this case, the trader would have started with $27,500 in cash, purchased and sold the bitcoin for a profit, and now they have a cash balance of $30,000 which includes the profit on the trade.

In the same example, if the trader bought the half stake of bitcoin and it dropped from $55,000 to $50,000, they would have lost $2,500 if they closed the position.

Cryptocurrency markets are unique in the sense that they are not governed by a central party. Cryptocurrencies can be bought and sold, and they are stored in wallets that are unique to each account holder. To buy or sell cryptocurrencies, traders and investors must have a crypto account that is connected to a cryptocurrency exchange.

Cryptocurrencies are digital currencies where ownership is stored on a blockchain, which is one of the differing characteristics when compared to traditional tangible currencies like the US Dollar.

Just like other asset classes, when supply is limited and demand increases, the price of the asset typically increases. Bitcoin specifically generates a lot of interest because the supply has a hard cap at 21 million coins. This means if there is global adoption and increase in demand, this can create upside price pressure. With that said, if bitcoin loses demand, because it’s a completely digital asset with no physical value, the price can plummet quickly.

WHAT IS A BLOCKCHAIN?

A blockchain is a decentralized ledger that records transactions. A blockchain is shared and immutable, which means data stored is irreversible and cannot be altered without the agreement of the network. These transparency and security measures are why many traders and investors look to cryptocurrencies as an alternative asset to fiat currency, which is controlled by a governing body. Blockchains store data in linked blocks via cryptography, so transactions can be traced back to previous blocks which helps to avoid fraudulent transactions.

In the simplest terms, a blockchain is a dataset that is linked, verified, and distributed. In the cryptocurrency use-case, a blockchain tracks transactions in a ledger, and each transaction is verified and stored in a block. Each of these blocks are then linked together, and they are immutable and decentralized which is why they’re considered so secure.

WHAT IS CRYPTOCURRENCY MINING?

Cryptocurrency mining, or more specifically bitcoin mining, is an intense computational competition to solve a cryptographic algorithm after a transaction is made between two wallets. When a transaction takes place on the blockchain, the wallet addresses, and the amounts are added to a block. All the data in the block is then sent through a cryptographic algorithm. This action is like auditing, since solving the algorithm successfully results in a bitcoin reward. This reward is cut in half every four years, which is known as bitcoin halving.

A successful bitcoin mine is energy-intensive. Many large companies that mine bitcoin have massive servers that use a lot of energy. It can take trillions of attempts to successfully solve a cryptographic algorithm. This is also known as hashing. A successful solve results in a hash, which is a 64-digit hexadecimal number.

For retail traders, the minute details of crypto mining may not be as important as understanding what it is, how it affects the landscape of cryptocurrencies, and how it can affect crypto companies that may be mining or buying cryptocurrencies.

When you research cryptocurrencies, a few terms continuously pop up. Here are a few crucial crypto terms to know:

• Blockchain: A blockchain is a database that stores data in blocks that are linked together with cryptography. Blockchain technology is what gives cryptocurrencies the ability to exist in a decentralized environment.


• Immutable: If something is immutable it cannot be changed or tampered with. In the case of cryptocurrency lingo, this term is used in reference to a blockchain, where data is stored and linked together historically in an immutable fashion. This is a key term used to describe the security of crypto technology.


• Cryptography: Cryptography is a method of protecting data in the cybersecurity world. Algorithms and codes are used to encrypt and decrypt data, and this practice is globally recognized as one of the best ways to protect data. In the world of cryptocurrencies, cryptography is used to maintain the security and integrity of blockchain networks.


• Decentralized: Something that is decentralized is not controlled by one person or source, but by many all at once. Cryptocurrencies are decentralized in the sense that they are not controlled by a governing body like a federal reserve or government. This is appealing to many crypto investors to get out of the traditional fiat currency systems that are in place around the globe.


• Bitcoin Halving: Bitcoin halving takes place about every four years, and it cuts the bitcoin reward for successfully verifying block transactions in half. In April of 2024, the bitcoin reward was cut from 6.25 to 3.125 bitcoin. This means that bitcoin miners are now receiving 50% less bitcoin for the same effort output. Bitcoin halving can disincentivize bitcoin miners moving forward, and it can also put an upward pressure on the price of bitcoin if demand continues to increase. Over time, all 21 million bitcoins will be mined, and supply infusions will halt.


• Mining: Bitcoin mining is the act of solving cryptographic problems to verify transactions on the blockchain. When bitcoin miners successfully verify transactions, they receive a bitcoin reward, which is currently set at 3.125 bitcoin. About every four years, this reward is cut in half and that is known as bitcoin halving. Bitcoin mining is an energy-intensive process, and mass-computing companies have built entire business models around bitcoin mining. Many anticipate that around the year 2140, all bitcoins will have been mined.


• Passkey: A passkey is a digital form of security that allows you to sign in on websites and apps and to verify devices without using traditional authentication methods like a username and password. An example of a cryptographic passkey is when you sign into a device and it asks you to confirm a 6-digit one-time code. An algorithm creates a random 6-digit code that lasts for a finite period and is only sent to you. Passkeys are now seen as a best practice for enhancing digital security in all aspects of life.


• Nodes: A crypto node is a computer that is involved in a blockchain network for transaction verification. Nodes are imperative to a blockchain network to ensure security and integrity of the network and the data that lies within the network.


• Tokens: Crypto tokens are assets that are built on top of an existing blockchain. Tokens differ from coins in the sense that crypto coins have their own blockchain. Bitcoin is a crypto; ether is the native token that exists within the Ethereum blockchain. Non-fungible tokens, or NFTs, are another example of tokens.

To start trading cryptocurrencies, you need to open a crypto wallet or a brokerage account that connects to a crypto wallet. At tastytrade, you can trade crypto, crypto stocks, crypto futures, and crypto ETFs all in one place. You can even link your crypto account to the tastycrypto wallet to access DeFi and Web3. Here is how to trade crypto at tastytrade:

1. Do your research to get an understanding of how crypto trading works
2. Open a tastytrade account or log in
3. Once the account is open, head to “trading preferences” under the “my account” section and enable cryptocurrency trading after reading through the Zero Hash connection process*
4. Create a trading plan and a risk management strategy
5. Open and monitor your crypto positions
6. Manage your crypto strategy and create an exit plan for potential profit and loss thresholds