Cryptocurrency CFD – the pros/cons of CFD vs Spot

Cryptocurrency CFD may sound like unknown territory for many, but there is a quite simple explanation. Since 2009 and the launch of Bitcoin, we have been hearing more and more about cryptocurrencies, but most of this conversation has centred around a mantra of buy and hold (or hodl for those in the know). For those not looking to just take that single approach, there is the cryptocurrency CFD.

What is a cryptocurrency CFD?

Simply put, a CFD is a derivative on the underlying crypto asset (see further information on what is a CFD in our dedicated article here). Essentially what you are doing when you trade a cryptocurrency CFD is speculating on the movement of the price of the asset to the upside (going long), or to the downside (going short). You would never own the direct asset itself, but you would be seeing a direct impact on your trading balance from the movement of the price up, or down, exactly the same as if you had owned the cryptocurrency directly and not via a CFD.

So what are some of the key differences between CFD and ‘Spot’ crypto trading?

Who you engage with is going to be one of the biggest differences between CFD and Exchange.

When trading cryptocurrency as a CFD, you will usually find yourself trading with an online broker who is acting as a ‘market maker’ to facilitate your trade. When buying or selling cryptocurrency directly, you will typically be engaging directly with an ‘exchange’.

The exchange is the actual marketplace for cryptocurrencies to be bought and sold, but similar to the stock market, additional trading venues are made available by brokers, or market makers, to provide additional liquidity to the market, and to improve execution.

What you actually get in exchange for your money.

If you are buying cryptocurrency on exchange/spot trading, you are getting the direct ownership of the underlying crypto in question. When buying 1 Bitcoin at a $40,000 trading value, you are committing $40,000 of trading capital, and in return you own 1 BTC.

As mentioned above, a CFD is not you purchasing the cryptocurrency directly, so you do not actually own the currency in question, but have a contract that guarantees you the right to buy or sell a certain volume of the underlying asset at a previously agreed on price. This guarantee, or contract, is provided by the broker.

For example, if Bitcoin is trading at $40,000, and you commit to going long (buying) 1 Bitcoin at that price via a CFD, you can typically use leverage of 1:2 with most brokers and commit $20,000 ($40,000 * 1:2) of your own capital to that trade. Whilst this would allow you to have twice the trading power as direct ownership, this has the potential to amplify your losses, aswell as your gains. When trading cryptocurrency as a CFD, you must manage your risk appropriately.

Why you are opening a cryptocurrency position will usually be a decisive factor in which method of entry you choose.

There are two main differentiators in this section, namely trade duration, and direction of trade. Let’s first consider trade duration.

Those that are considering a long term hold of cryptocurrency, would typically be well advised to open a position without leverage, or spot trade. This is due to the fact that there are no fees attached for holding your position open overnight, or over many months.

Those that are day trading or swing trading a position, and expecting significant moves in their trading direction may be more open to considering trading their chosen crypto via CFD, as this allows the use of leverage to amplify results. Someone considering a short term position may also execute direct to exchange should they not wish to use leverage in their trade.

On the other hand, trading direction is far more flexible when trading cryptocurency CFD, as opposed to spot trading. Why is this? Quite simply, if you anticipate the price of a particular cryptocurrency to move to the downside, when trading direct to exchange you have no option to take advantage of this downside movement. You could wait for the expected downside movement to be complete and then open a long position to profit from upside gains, but you cannot participate in the profit of the market drop via this method.

With cryptocurrency CFD trading, you will remember we have highlighted you can trade in either direction, regardless of your current position status. How does this work you may wonder? Well, the broker is willing to sell you a contract on the movement of cryptocurrency to the upside or the downside because they will charge you a small transaction fee (or spread) when you execute your trade.

Seeing as you do not own the asset in a CFD, you can speculate in either direction and potentially profit from drops in the market price, as well as gains. This is provided by the ‘market maker’. It is for this direction element and the ability to ‘hedge’ positions, that many cryptocurrency traders will have both active accounts with crypto exchanges, aswell as crypto CFD brokers.

Using Cryptocurrency CFD to hedge open spot positions?

Whilst it may seem counter-intuitive to want to have open positions both to the upside and downside on a single cryptocurrency, it is exactly this strategy that is used by many active traders to hedge their long-term bullishness. How does this work and why is it viable you may ask?

Imagine the below scenario.

You are an avid cryptocurrency enthusiast with an absolutely unshakeable faith that the price of cryptocurrency, and XRP (Ripple) in particular will be on an undeniable upward trend over the next 10 years. This is your long position, and you have no intention of selling your XRP until you retire. You have decided therefore to tie up your XRP in a cryptocurrency savings account to earn an interest on your holdings whilst you wait for the inevitable rip.

Recently however, XRP has been experiencing a lot of downward pressure due to a regulatory investigation that is ongoing with the US regulatory bodies and whilst your crypto positions are in savings accounts you are reluctant to close, you would like to hedge some of this downside risk.

What are your options?

Your options at this stage with your exchange account owned XRP would be to sit on your hands and wait to see what is the outcome of said investigation (which could have an extremely bullish or bearish impact on the short-term value of your XRP).

The second option would be to try to close your savings account, incurring any potential penalties you might have, and then to execute a sale of your beloved crypto at a time when a lot of the doubt and negativity is already priced in.

There is a third option that comes into view with hedging via cryptocurrency CFD trading.

This would involve opening a trading account with a crypto broker, and taking a downside position to mitigate the size of any losses during any short-term drops in price. All this whilst retaining your cryptocurrency savings account and XRP tucked away for interest payments, as well as any potential future growth.

The short trade in this scenario could be a completely different size to your original XRP position if you are more bullish than bearish, but you can maintain control over your risk.

With the right use of position sizes, it is possible through such a technique to remain market neutral during certain phases, so that any movement to the upside or downside, as well as any profit and loss incurred in either direction, is negated in the other account.

Through such a technique, it is also possible therefore to retain your interest payments from your savings position, whilst the market is deciding in which direction to turn. Once that long term direction becomes clear, it would still be possible for you to have protected your underlying position with the functionality provided from your cryptocurrency CFD trades.

Advantage of direct exchange vs Cryptocurrency CFD

  • Fewer fees to be paid. If planning to hold an open position for an extended period of time, spot trading will only usually incur transaction fees when you execute a position (buy or sell). If the same strategy is used via crypto CFDs, you will usually have other fees (overnight fees) that are associated to your using leverage which is essentially borrowed capital from your broker. These fees are usually quite small in percentage terms, but when amplified over a long hold period, can be quite substantial.
  • Effective for short or long term holds.

Advantage of CFD vs direct exchange

  • ability to trade in either direction on the price.
  • the availability of leverage to amplify your trading capacity

Trading Cryptocurrency CFD – which brokers are safe to trade with

Cryptocurrency CFD brokers are growing by the day, and it is becoming a little more difficult to differentiate one from the other.

To be a crypto broker, you do not necessarily need to be regulated, as the market itself is not regulated. That being said however, there are many cryptocurrency brokers nowadays that have started life as stock brokers, forex brokers, or CFD brokers. The good news there is that these markets are in fact highly regulated, and as such, the brokers that provide access to multiple instruments are also regulated highly as a result.

We will highlight cryptocurrency CFD brokers below that hold regulation under the most stringent of Tier 1 regulators in the financial trading industry.

eToro – trading juggernaut with regulation stretching across the globe in multiple jurisdictions.

This is a cryptocurrency broker that will allow to trade with or without leverage, effectively becoming a facilitator of both direct ownership, aswell as CFD trading of crypto. The spreads to execute a position here are a little higher than you will find with a pure exchange, but you can of course choose where to execute various trades depending on your strategy. Please note that if you are a US resident, it is not possible to open CFD positions or positions with leverage.