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CryptoCurrencies: Trading Digital Currencies

You have read it in the newspapers. You have seen in online. You may have read about it in one or two forex forums. 

Yet, the question remains, how do I trade a cryptocurrency and which one do I trade? 

In this post I am going to give you a simple overview of how crypto currencies such as Bitcoin and Ethereum work. I will also take you through some of the current trading strategies that are being used to profit from their volatility.

What is a CryptoCurrency

Cryptocurrency is not really an actual physical (or even digital) asset but is a cryptographically signed proof of work. In non-technical terms, this means that it is a record of a transaction that was verified using mathematical functions.

These records of transaction are stored in a public ledger. In this case the public ledger is called the "blockchain". When you send some Bitcoin to someone else, this is entered onto the blockchain and is verified by a number of computers called "miners". 

If this sounds slightly foreign to you, then you need not worry. All that is important to understand is there are numerous benefits to a cryptocurrency that one does not have with FIAT currency. 

One of these is that they are not subject to the whims of a central bank to supply them. Since the financial crises in 2008, many people have lost faith in banks and traditional methods of finance. 

With Cryptocurrency, there is no need for a financial intermediary. It is an open source project and hence is open to the public. It is also much cheaper to send and receive money using the blockchain. 

Moreover, there is a natural limitation in global supply of the currency. This comes down to the way in which it was originally developed. The difficulty that comes with mining the currency increases slowly year by year. This means that the amount of the currency that can be produced gets less and less over.

Ether vs Bitcoin

Bitcoin and Ethereum differ in a few distinct ways. Although both use a public ledger, Bitcon is more likely to face supply limitations than Ethereum. 

The distribution of Bitcoin and Ethereum also differ. Most of the supply of Bitcoin is held by the early miners of the currency. Ether, on the other hand was crowd funded which means that it is more evenly distributed. 

Ethereum is also viewed as a more advanced crypto currency with smart contracts which could have wide ranging applications and uses. For example, many people are looking at the potential for one large decentralised "virtual machine" which could fundamentally change the way that we view current web infrastructure.

Trading CryptoCurrncy

Now that you have a vague understanding of what cryptocurrency is, you are ready to start entering trades on the pairs. Before you can start executing trades, you need to be registered on a trading platform. 

There are a number of Forex and CFD brokers who will allow you to trade them on margin. However, if you want to purchase the currency over the long term with and not incur any roll over fees then you can use an exchange such as Coinbase or bitstamp.

Trading Bitcoin

For those people who have been following Bitcoin over the years, they know how volatile it can be. This is because of a number of factors. It is usually seen as a store of value and is as such always driven by Macroeconomic events. 

There is, however, a much larger driver of the volatility and that is China. Retail investors in China face numerous exchange control restrictions that make it hard for the citizens to get their hands on hard currency. As such, Bitcoin is the de facto asset that they choose to trade. 

Over the past 2 months, Bitcoin (BTC) has seen some of that really characteristic volatility. In the middle of March, it went briefly above the price of gold at $1,300. This was on the hope that a Bitcoin ETF would be authorised by the SEC. 

However, when traders learned that it had been rejected by the SEC, it fell to $900. Yet, true to form Bitcoin recently breached $1,215 again. This was on the back of mainstream adoption in Japan. 

Indeed, BTC tends to be driven by a number of fx trading signals that are more familiar to traditional forex traders. These include most of the patterns as well as other charting indicators. 

There are indeed a number of professional investors who foresee BTC breaching $2,000 by the end of 2017. This is mainly based on large geo-political risks that appear to be cropping up in a number of regions around the world. This, together with a lack of clear U.S. economic policy is leading to uncertainty. 

As any seasoned gold trader will tell you, when there is uncertainty, there is a flight to quality. BTC has become one of those de facto save havens. There are also a number of other more technical reasons that BTC is likely to increase substantially in price however. These mostly come down to Blockchain effeciencies.

Trading Ethereum

The Ethereum project is indeed garnering extensive global interest. This is down to the potential revolutionary way in which the smart contract technology that underlies the currency can be adapted to other applications. 

We have also seen that Ethereum (ETH) has shown it can be just as volatile as Bitcoin. It increased from about $16 in February to reach over $50 in mid-March. Although is has consolidated slowly since then, there are many analysts who still see large upside potential. 

This comes down to many of the same factors that are driving BTC such as safe haven status and Chinese regulations. However potential scalability issues with Bitcoin are another reason why more and more Bitcoin users appear to be migrating. 

Hence, if the Blockchain is not made more effecient and transaction times keep increasing, then it is indeed likely that the bottleneck in supply will eventually flow out to the benefit ethereum. 

Indeed, BTC and ETH have exhibited inverse correlation over the past few months.

Conclusion

Although many Bitcoin users may use Ethereum, the two crypto currencies are quite different in form and function. Both are likely to benefit from mistrust in traditional financial institutions as well as central banks. There may be volatility in the interim but the long term adoption of Cryptocurrency in general is likely to rise. 

Hence, a long position for Cryptocurrency over the next 4-8 months would add weight to the Forex Trader's portfolio.

 

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12:30 US- Housing Starts & Permits
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John M. Bland, MBA
co-founding Partner, Global-View.com

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