If you’re new to crypto, this article will tell you everything about using exchanges to purchase and trade cryptocurrency in the most complete way possible.
Cryptocurrency is usually purchased, sold and traded on exchanges. These platforms come in many shapes and sizes, have tons of features and can be very confusing. Exchanges provide a “price discovery” for cryptocurrencies and for many people they provide a means of income by trading. While it may sound a bit confusing to many people, the basics are actually very simple. So let’s lift the veil from this mysterious topic and explore all the ins and outs of exchanges together.
Types of cryptocurrency exchanges
There’s certainly nothing more confusing than the topic of exchanges. Where to buy crypto? How is it done? What platforms should be used? Questions are endless. So let’s start by looking at the types of exchanges that are out there.
In the beginning there was darkness. When Satoshi created bitcoin and saw that it was good, the only way to buy the damn thing was through forums and message boards where programmers and cypherpunks lingered and converged. This kind of system of person to person exchange still exists today in the form of platforms like Local Bitcoins and Local Monero. Anyone and everyone can buy and sell cryptocurrency using any type of payment method they prefer. Cash, Bank Transactions, Paypal, you name it! The main disadvantage of these platforms is that of course it’s all happening very slowly. You are establishing trust between both parties and there is of course tons of ping pong communication that needs to be done before your very first coin is even purchased.
Enter Centralised Exchanges! These juggernauts like Binance, Crypto.com, Coinbase, Gemini, Kraken, Bitpanda and many more have evolved over the years to become the largest platforms on the internet where buyers and sellers meet and conduct their business in the fastest and most efficient way possible. People can play with leverage and use tools like “stop loss” for protecting the stability of their positions. Aside from that, there’s a plethora of charting tools for scouting those nice trading opportunities. Some exchanges also provide a treasure trove of educational material to help new investors and traders to get started. Binance for example even has its own academy to help new traders on their way.
The very first centralised crypto exchange was MtGox. The story behind it should be mandatory learning material for any crypto investor, simply because when it came crashing down ( robbing the people from all of their coins ), it created a precedent that will be repeated in the future. MtGox 2.0 can happen and we will discuss risks in the following chapters.
These days decentralized exchanges are also picking up steam and slowly becoming large players to be reckoned with. A decentralized exchange is nothing more than a computer program that lives in cyberspace and allows users to buy, sell and trade coins ( Usually coins built on the Ethereum network ) without conducting any KYC ( know your customer ) regulations. The biggest decentralised players at the moment are off course: Uniswap, 1Inch, Sushi Swap and Kyber. For new investors out there, centralised exchanges would definitely serve a better purpose in order to get up to speed as fast as possible. We know you’re excited, but for the sake of never repeating the painful lessons of MtGox, let first explore what you need to know before you even deposit your first USD, EURO or YUAN into an exchange. In the crypto world, only the paranoid survive!
A centralised exchange will usually greet you with KYC ( Know Your Customer ) requirements. This is done in order to make the clients compliant with the laws and regulations of their countries and in order to ensure that no dodgy affairs ( like money laundering ) goes through the exchange. The KYC process is very straightforward and takes just a few minutes to complete. Users must verify their identity and usually show one or 2 “Pokémon cards” like their ID or Driver’s licence.
Second point of your crypto adventure should always be security! It’s self explanatory that your password cannot be 1234 any more. Those days are long gone and today there are literally thousands of boiler room scam offices operating worldwide in order to gain access to your funds. So not only does your password need to be bulletproof, it should be backed up on at least 3 pieces of paper and never stored digitally.
Sadly a password alone just won’t cut it any more, so it’s imperative that you always use 2FA ( 2 factor authentication ) in order to protect your account. Simply explained 2FA means that aside from your password, you will need to knock on the door of your account using a second device ( or app ) like an SMS text message code of Google authentication app. Sometimes hackers manage to defraud phone companies into resetting a user’s sim card and gaining access to 2FA by text message. This is called “Sim Swapping”, therefore a tool like Google Authentication is much more reliable. But please don’t bite all the nails off your fingers just yet, simply because you plan to invest a 3 or 4 digit number into a centralised exchange. If you’re smart and keep your crypto investing as private as possible, the risk of being hacked is actually very low. Now you got your paranoid hat on and your desk is littered with paper notes full of passwords and authentication backups, let’s take the last step!
When you finally calmed down a bit, take a sip of coffee and let’s get down to business coupling your debit/credit card to the exchange. Usually this is the last step in the whole chain. You got everything set up, now you can safely buy your first crypto currency. The process is usually very straightforward and self explanatory, so we won’t dwell too much on it. First time investors usually opt for buying Bitcoin or Ethereum as their first coin, simply because it’s tradeable for so many other coins. Of course that all depends on the exchange that you’re using. Now let’s dissect the exchange itself and clear up all the mystery behind the imposing and complicated facade.
How orders work
In the good old days the market was a town’s square where loud and entrepreneurial people converged in a chaotic shouting match that resulted in what’s called: price discovery. Some folks had products for sale ( bid ) and others were looking to buy ( ask ). After an extended haggling session, the price was agreed somewhere in the middle as it usually goes. This is exactly what happens in a centralised exchange. But right now no shouting, cursing and waving paper notes is required. The whole process of price discovery operates in a nice, quiet and digital serenity.
You place orders to buy and to sell cryptocurrency. That’s it! Not so difficult right? There’s an orderbook that displays all the offers to buy and offers to sell. In the middle they converge into a point and presto! You have price discovery and thousands of orders are executed every single second.
The patient trader always opts for placing “Limit Orders”, because the price that you input in your order differs from the current price discovery. For example: A coin is trading at 10 usd, but since you’ve done your research, you know that it’s currently too overpriced, so you are comfortable paying only 3 usd for it. Subsequently you put a “Limit Buy Order” for 3 usd, close your computer and go on holiday to Bali. When the price drops to 3 usd, your order will automatically be filled and you’ll find yourself a proud owner of a coin that has cost you only 3 usd to buy. Sweet!
If you’re a bit impatient, or if you have good reasons for it, you can of course always use a “Market Order”. This means you buy your coin at the price that it’s trading at this exact moment in time. A market order is very useful in case you don’t plan to follow the price action on a daily basis. Some long term investors actually prefer to use market orders in order to save time on their shopping spree. Not everybody has the time to go to Bali remember?
Now imagine that you’ve bought your coins ( in trading lingo that means you have an “open position” ) and you don’t have the luxury or time to babysit your treasure until it reaches the comfortable selling price. At some point you do need to sell your coin after all ( this is called “closing your position” by the way ). No problem! There’s a tool called a “stop loss” that can literally save you a lot of time and headache.
Jane bought a coin for 1 usd. She’s very optimistic about it and after conducting her due diligence, she’s expecting the price to rise to 3 usd in the coming week. She wants to let her coin ride the upwards price movement, but at the same time she wants to limit her risk as well. When her coin reaches the price of 2 usd, she sets a “Stop Loss” at 1.9 usd. This means in case Jane is out shopping or walking her dog, she’s not worried about taking a loss on her current holding ( her open position ), because should the price would decline, her order would be automatically triggered and her coin would be sold at the price of 1.9 usd netting her a handsome gain on 0.9 usd in the process. This all happens while she’s shuffling the shopping bags in her hand trying to prevent her dog from running off chasing squirrels. Again no need to babysit your open order.
Tools like stop losses are essential for all people. Only amateurs or seasoned professionals ( usually glued to their screens ) conduct their trading without them. As of 2019, leverage exchanges have become all the hype. It’s very important to know about them, so let’s dive right in.
The Holy and Diabolical leverage
While the financial lingo is purposely made as complicated and confusing as possible, leverage simply means “doing more with less”. A road worker uses the “leverage” of an excavator to dig a trench in minutes. Without leverage it would take hours of hard work swinging a shovel. A cyclist uses the leverage of his bicycle in order to arrive at his destination faster than by simply walking. Not complicated at all!
In our case a trader is using a 10x leverage in order to put down 1 usd of his own capital and borrow the rest from the exchange in order to multiply his potential gains. Here’s where things start to get dangerous very fast! You see leverage is a tool that works in both directions. Your earned profits will be multiplied by 10, but so will your losses.
It’s very important for new traders to learn before even considering playing with something as explosive as leverage. It takes years of hand work and endless mistakes to learn the art of trading. During this period the trader should never touch leverage, because if things go south, your “open position” will be liquidated as soon as the price moves against you by just a few percent. Simply put, the exchange will sell off ALL the coins that you currently have in order to pay for your dept.
Some exchanges even use 100X and higher leverage. That is the equivalent of giving a monkey a nuclear warhead to play with. It’s very irresponsible to say the least. Besides the orderbook ( the total amount of all the orders on the exchange ) is always visible to the owners of the exchange and there have been many reported cases when the exchange itself was implicated in price manipulation in order to “trigger” automatic sell orders ( called liquidations ) when they saw that too many people with leverage were standing on one side of a trade. For the avid fans of Technical Analysis, just look up the “Bart Simpson” pattern and you’ll understand how it works. New traders beware! For now just stick to “spot trading” ( meaning only trade with the amount of money you have ) until you master the skills properly. In general many different people use the exchanges on a daily basis. Not only traders. These people are also called holders ( or hodlers in crypto lingo ) because they “Hold On to Dear Life” throughout the insane volatility. Some jokingly say that the people who got truly rich from crypto currency, are the ones who bought it many years ago and simply forgot that they even had the damn thing. Yes the volatility can be brutal!
Trading vs Holding
Many people who first start out in crypto are actually not interested in trading. They prefer to hold on to their coins and profit from the rising price during a “bull market” ( a period of trending rise in price ). These people also love to use exchanges.
However ALL professional traders who love to ride the volatility, also have a “HODL portfolio” of untouchable stash of coins that they are sitting on. Usually the Hodl to trading portfolio varies between 80/20 to 98/2 percent. So even the most adventurous traders out there love to sit on a long term stash of their favourite coins, while using a tiny part of their total portfolio to trade with. The monkey puts down the nuclear warhead and tries to play with a grenade instead. After the smaller collateral damage is good for everyone.
Here is where you should grab a pen and paper and take many notes. In order to protect this sacred HODL portfolio, it’s very important NEVER EVER to store this long term treasure on a centralised exchange. No matter how safe the exchange claims to be and no matter how reliable an exchange is, a second MtGox 2.0 scenario is bound to repeat itself one way or another. That means it’s inexcusable for traders and hodlers alike not to have what’s called a “cold storage wallet”. This is simply an electronic device ( that usually looks like a flash drive ) where a person will store their private key ( meaning storing the physical proof of ownership of his/her cryptocurrency ). There are many good cold storage wallets out there. Ledger and Trezor are perhaps the most famous ones.
Exchanges come and go. Just like empires of the past they rise and fall. Aside from history books, what remains from these empires is usually architecture and most importantly gold and silver coins. A prudent trader and hodler alike never leaves anything to chance and ALWAYS takes full physical delivery of his cryptocurrency in order to store them safely on his/her own device. If you fail to grasp this concept, then perhaps cryptocurrency is not for you. If you understand this, let’s continue and point out a few other important aspects of centralised exchanges that we need to remember.
Risks and hidden dangers
By now you have your basics covered and we hope you are already digging nose deep into a few good books on investing and trading ( The Rational Investor ) should definitely be on top of your reading list. Let’s take a moment to explore all of the risks that can rear their ugly head while you’re using decentralised exchanges.
The biggest and the most dangerous risk for any investor is ( are you sitting down? ) … the investor himself. Yes that’s right! Many people are just too eager to get started in crypto trading without doing the necessary work. Before you jump into a crocodile infested lake without a parachute, it helps to do a lot of research and study. Consider this article to be your guide, but realize that there is a lot more to learn. Your knowledge will become a titanium chainmail armor that will break the teeth of any market crocodile who would try to mistake you for a noob. This is exactly why the time that you spend on your education will guarantee you those exponential profits and most certainly not the advice from a pump and dump group to buy Dogecoin.
The second most important risk as we already mentioned, is off course leverage. Again just like a heavy rainfall, it’s just a tool. To a farmer, it’s a godsend. To a rabbit who gets flooded in his burrough, it’s a death trap. When you sharpen your teeth with tons of experience and when you make many mistakes along the way, you will become a farmer and the rain of leverage will help you grow plenty of green and delicious crops for years to come.
The third most important risk is off course the risk of the exchange itself. You see since 2020 we are heading into uncharted territory and one needs to be prepared for pretty much any scenario. This year especially will be plagued by lawsuits, bankruptcies, scams and malpractices alike. There will be new Bitconnects rising up to profit from the ignorant and impatient newbies. Reputable centralised exchanges will suddenly go bankrupt or will get shut down due to regulations. Coins will get delisted, malicious CEO’s and managers will go into hiding or to prison. This year you can expect literally anything! Therefore “Not your keys, not your coins” should be the mantra that must accompany you throughout your morning routine. If you have a hodl portfolio, please take it into your own possession and protect your wallets with a watchful eye of a seasoned and paranoid crypto investor. Speaking of emotions, let’s check out the most important part of the art of doing business on exchanges, shall we?
Psychology of a trader
The traditional markets are pretty tightly regulated, making them a lot safer, but at the same time a lot more boring as well. Crypto on the other hand, is a culmination of all the human emotions packed into an unregulated methamphetamine abusing Finnish F1 racer. It’s fast, violent and unpredictable and if you miscalculate your moves, it will rip the pants right off your ass. This is why it attracts so many people. Why are you reading this article after all?
In order to stomach this kind of stress, sleep deprivation and caffeine abuse, you’ll need to dig down into your core essence, become honest with yourself and realise a few important facts.
At some point you WILL lose money. You have to be ready for it and unlike back in school, in this market there are no right or wrong answers, only lessons. These lessons can be cheap or expensive depending on the amount of greed and fear that accompanies any particular trader.
The core essence of greed and fear is what moves the markets. Remember we are a very young and unpredictable market and just like Icelandic weather, we can change on a dime. This is why mastering your emotions is so damn important. You see we were never taught about money and how to profit from speculative opportunities. Naturally we become nervous and even apprehensive when these opportunities present themselves. Therefore you must completely detach yourself from all of your beliefs about money ( that have been usually formed by parents, teachers and friends ). Expect to win and be prepared to lose and to learn from it.
When all the dust settles, when the next 4 year crypto bull cycle ends in tears for thousands of investors, realize that your success will be determined by how long you can afford to STAY IN the market and not by the amount of money you earn. Because only experience and skill is what counts at the end. It is the core essence and it will shape your personality and even the world around you.
This is why lottery winners squander their winnings after just one year. They are never ready for success and without expecting it, they don’t have a clue how to manage it when fortune blesses them with sudden financial gains. A successful trader and hodler is ready to bite the bullet, to lose and even to wait for 4 grinding soul crushing years in order to collect his/her profits while literally everyone around is declaring him/her to be insane. This game is played over the long term and luckily for you, the seasoned veterans usually take kindly to newcomers who are ready to listen and to learn. Now you have your work cut out for you, so get cracking!