BlockchainIntroduction to Bitcoin Trading

Introduction to Bitcoin Trading

What is Bitcoin?

Bitcoin is a digitally created currency – or cryptocurrency – based on a decentralized peer-to-peer application and registered on the ‘blockchain’. Invented by a developer using the pseudonym ‘Satoshi Nakamoto’ in 2008, Bitcoin was revolutionary in having no central bank to control its uses or movement.

Bitcoin’s value against fiat currencies – like the dollar or the euro, whose value is established by the government that backs them – is determined by supply and demand and by market events. Investors now see Bitcoin as a valuable alternative to other traditional government-backed currencies. Bitcoin (BTC) is actively traded against most of the other major currencies in the world and is held in digital wallets. These wallets have private and secure encryption and allow users to transfer Bitcoin to other users privately and safely.

Why Bitcoin?

No banks are involved, and money doesn’t have to pass through any middlemen. And since Bitcoins aren’t tied to any country, and are completely decentralized and not subject to any external regulation, international payments are easy.

An Atypical Currency

Bitcoin is unlike any other, traditional, fiat currency due to its decentralized nature. The digital currency can be bought using fiat currencies and also by using other digital currencies. It is important to realize that Bitcoin is highly volatile and has little regulation. That in turn can translate into considerable risk with the exposure that is not properly tended.

Where do Bitcoins come from?

The maximum number of Bitcoins allowed to be created and the methodology behind the
process of creation is set out in a so-called ‘White Paper’.

Bitcoins are computer generated using a mathematical formula. They are created by
being ‘mined’ by individuals on the blockchain network. To become a miner, an individual
needs a computer and special mining software. Miners allow their computer
resources to be used to solve complex mathematical equations, processing, and
securing ‘blocks’ of bitcoin transactions which are then added to the blockchain. In return, miners receive Bitcoins as payment.

Currently, 12.5 new Bitcoins are mined every ten minutes. According to the rules set out by the White Paper, in total, a maximum of 21 million can be mined. These coins are mined at a predetermined rate, and roughly every four years the amount of coins mined is halved. There are currently around 16.25 million coins in circulation and the maximum
of the amount of Bitcoins that can be mined is expected to be reached in 2040.

What are the Alternatives to Bitcoin?

Alternative currencies launched after Bitcoin are called ‘altcoins’ and created using the
same basic framework as Bitcoin. The best-known altcoin is Ethereum. Created by Vitalik
Buterin, Ethereum is based on a decentralized platform and runs smart contracts – applications that operate without the possibility of censorship, fraud and downtime
or third-party interference.

Market Conditions: The cryptocurrency market is extremely volatile and requires a disciplined trading approach. The market is still in a developmental stage and, when coupled with the extreme price moves experienced, risks overheating. Many commentators see a ‘bubble’ forming, drawing comparisons with the financial crisis of 2008, the ‘dotcom’ bubble of the late 1990s and early 2000s, and even the ‘tulip mania’ of the 16th century.

Hazard and Risks

Warnings by the US supervisory authority, the SEC, and the German central bank about the unpredictable nature of the Bitcoin market warrant attention. In March 2017, the Winkelvoss twins’ application to launch a Bitcoin-based exchange-traded fund (ETF) was rejected by the SEC for lack of regulation, causing the market to temporarily collapse.

How do I Invest in Bitcoins?

Spot – Coins

Many Bitcoin exchanges allow the ‘physical’ purchase of Bitcoin, stored in an electronic wallet. This wallet can be set up on a smartphone, a tablet, or a computer, allowing the holder to see price movements in real-time. Many of these exchanges are deregulated and offer little comeback in the case of any financial dispute. There have also been reports of exchanges being hacked and customers losing some or all of their cryptocurrency holdings without legal recourse.

Derivatives – CFD Trading and Spread Betting

Contracts for difference (CFDs) and spread betting provide a way to benefit from the
fluctuations and volatility of a digital coin. Payment is made on the difference in the settlement, without having to actually exchange the cryptocurrency. These alternative products have a number of advantages compared to trading the underlying market. Funds generally need to be held in a segregated and secure account, giving you greater peace of mind. And CFDs and spread bets operate on margin, so you can use leverage. Plus you can also take short positions to capitalize on falling markets – a feature valued by most experienced traders.

Matthew Leising
I cover market structure for News Alarms, specifically how the bond, derivatives, and cryptocurrency markets work or don't.

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