As traders, our job is to take advantage of opportunities in the markets. Sometimes, these opportunities come in the form of entirely new markets.
I've been interested in cryptocurrencies for a few years now, but I've been very reluctant to trade them, much less write about trading them. I felt that there was just too much risk.
Especially for the average trader.
…and quite frankly, I didn't understand them well enough myself.
The first time that I saw them as viable for trading was when I went to this conference. I saw Chris Dunn talk about trading Bitcoin, but I was still skeptical that it would stay around for the long-term.
I credit my friend for talking to me about it on Twitter and opening my eyes to the potential in trading this emerging market. I'm not sure if he wants to be named, but you know who you are. I sincerely appreciate the education and helping me see the light!
This is a perfect example of the benefit of staying in touch with other traders on platforms like Twitter.
Anyway, as I have done more research and have actually started trading them, I have found that there are tremendous opportunties. With some coins, it's potentially like being able to get pre-IPO shares of Microsoft.
But there are also big risks.
Remember, the dot-com bust?
There will probably be losses of that magnitude too. That's just how these new technologies work.
So in this post, I want to share with you my knowledge of the cryptocurrency markets and give you a total beginner's guide to trading them. Be sure to bookmark this page because I'll continually update the information, as things change.
For you crypto veterans, this will be very simplified, but my goal is to make this information as easy to understand as possible so new traders can make an informed decision about the opportunities. Once people get the general concepts, then they can geek out about the details.
This is the future of FX trading. So in addition to USD/CHF, CAD/JPY and EUR/GBP, we also need to be aware of XLM/USD, ETH/BTC and XRP/LTC…
Table Of Contents
What is a Cryptocurrency?
Let's start at the beginning.
You may have heard many things about what a cryptocurrency is, but you may still be searching for an understandable definition. I hear ya, I was in the same boat for a long time.
Instead of getting to technical, here's the easiest way to think about cryptocurrencies:
Cryptocurrencies are basically the money on software platforms.
It's important to keep in mind that the teams/companies that are behind these cryptocurrencies are not only creating a new form of currency, but a new software platform. To demonstrate how this works, let's take a look at other software platforms that you are probably already familiar with.
Examining how these platforms work will help you understand cryptocurrencies.
Here are a few software platforms that many people use:
- Windows: A software platform for personal computers
- Dropbox: A software platform for storing and sharing documents
- Fedwire: A software platform that sends money between financial institutions
On each of these platforms, a type of money is used, in exchange for using the platform:
- Windows: You pay US Dollars (or your local fiat currency) to buy a license for Windows to use on your computer. If you buy a computer that already has Windows on it, the license fee is included in the purchase price.
- Dropbox: You pay US Dollars (or your local fiat currency) to buy a subscription to use the software for a month or a year, depending on which plan you buy.
- Fedwire: You pay a transaction fee to use the system and you send fiat currency itself.
Each of these systems also have a database connected to it:
- Windows: Database is stored on your local computer
- Dropbox: Database is stored on the Dropbox servers
- Fedwire: Database is stored on the Fedwire servers
Cryptocurrencies essentially replace the US Dollars (or your local fiat currency) that you use to purchase these software services. The “database” that cryptocurrencies give you access to is based on blockchain technology.
More on blockchain technology in the next section of this guide.
But wait, what are the software services that you are getting? Isn't a cryptocurrency like Bitcoin just a currency, like US Dollars?
The goal of cryptocurrencies is usually to improve on some type of existing software system or network. When you send money via PayPal, Fedwire or Western Union, you are basically sending fiat money electronically, similar to Bitcoin.
However, that's where the similarity ends.
Platforms like PayPal have severe limitations on what you can and cannot do. For example, you cannot send/receive money from certain countries (like Nigeria).
Cryptocurrencies like Bitcoin want to make financial transactions more open and accessible to everyone around the world.
Other cryptocurrencies solve other problems, which we will explore later in this guide.
Is Cryptocurrency Real Money?
Since this is a new concept to most people, it will take some time to become widely accepted. This is where Bitcoin has been instrumental in paving the way for this new technology.
Websites like Newegg take Bitcoin, along with the other traditional payment methods. Here's what the checkout screen looked like after I added a drone to my cart.
Payment processor Stripe also allows online merchants to accept Bitcoin.
Notice that other coins like Ether or Litecoin are not accepted. However, the fact that Bitcoin is accepted, is a big step towards the adoption of other cryptocurrencies.
Risks of Cryptocurrency Trading/Investing
Now that you understand the basics, what are the risks of trading these cryptocurrencies? There are quite a few, but here are the top three.
1. Some Technologies Will Fail
Remember that cryptocurrencies are basically software, created by people or companies. So just like Webvan or Pets.com in the dot-com bust, some of these technologies will fail.
…and they will fail spectacularly.
Right now, there is a lot of buzz around certain cryptocurrencies increasing several thousand percent, in a few months. This has a lot to do with ignorance and hype.
Just like when people found out that this new thing called the “internet” would change the world of business.
Did it change the world?
But was there a lot of dumb money that overhyped the first wave of internet companies?
So just remember, trading cryptocurrencies is kind of like trading a software stock. Some of the software will change the world.
Others will explode in a giant ball of fire.
There are also a lot of scam coins out there, so be careful. Like penny stocks that are just a company on paper, almost anyone can create a new cryptocurrency.
Learn how to separate the scams from the deeply underpriced currencies. Then use proper risk management and play the odds.
2. It Requires Technical Savvy
Let's face it, cryptocurrencies were created by super nerds. Like with Linux, there is still quite a bit of technical know-how that is required.
You don't need to know how to code, but if you are “not good with computers” you may want to stay away from cryptocurrency trading, at least until they start building more user friendly interfaces.
Don't get me wrong, I'm not calling anyone dumb. I'm just saying that if you don't possess a certain skillset, then you shouldn't get involved in that area. This could cause you to lose a lot of money, very quickly.
For example, I don't know how to sew, so I don't make my own clothes. If I did try to make my own clothes, everyone who meets me would think I'm a weirdo for wearing fucked up pants.
You get the picture.
So if you aren't so tech savvy, but still want to get involved, find someone you trust to trade for you.
3. There's a Lot of Broker and Technology Risk
Since this is emerging technology, there are still a lot of unknowns with trading at scale and how brokers and the software will react to certain surprise events. If you think that Forex brokers are risky, then you should consider cryptocurrency brokers at least twice as risky. Not just because they could be shady, but there a still so many unknowns with the technology.
However, I would still trust the bigger cryptocurrency exchanges over a lot of offshore binary options brokers 🙂
So the lesson is: Don't keep too much of your coinage at the brokers. Move them off to your own wallet as soon as possible.
I'll get to wallets later in this guide.
What is a Blockchain?
Simply put, a blockchain is a database.
However, there is one huge difference between how you probably currently think of a database and how a blockchain database works. In most cases, a traditional database sits on one computer or in one location.
Even if a company has redundant servers around the world, the data might only be backed up between 3 to 5 locations. On top of that, these companies collectively spend billions of dollars a year on cyber security.
With a blockchain database, the data can be backed up on potentially thousands of computers all over the world, for a much, much lower cost. The information in these databases is heavily encrypted and sometimes files are broken up into pieces, so even if one piece is exposed, it will not expose the entire file.
If the information on one server does become compromised by hackers, the other copies of the databases have to “agree” that the compromised data was a legitimate change to the data. If the other copies do not agree, then the change is rejected and it is changed back to match the others.
Obviously, this is an oversimplified explanation of the technology, but I hope that you are starting to see the benefits.
Instead of just one point of failure, like on a single server, you now have multiple copies of the same database all over the world that is almost impossible to crack and will “fix” itself in the case of a hack. This can also save a ton of money on cyber security software and services.
Let's say that a hacker gets into your bank's computer tomorrow and transfers all of your money to his account, then deletes any trace of the transaction. With today's technology, you would probably be screwed.
But with a blockchain currency like Bitcoin, if one server was hacked and a fake transaction was inserted into the database, then it wouldn't match the transaction record on the hundreds other copies of the database. This transaction would be seen as a fake and rejected.
Your money would be safe.
This is one of the many reasons why blockchain technology is so exciting.
The Characteristics of a Currency to be Aware of
Although cryptocurrencies are all based on blockchain technology, they are not all created equal. Here are some differences that you need to understand to make informed trading decisions:
- Transaction processing speed
- Total supply currently available
- Will there ultimately be a limit on the total number of currency available?
- Will there be an unlimited supply of currency?
- Is there a real-world need for this software/currency?
- Real world adoption of the technology
- Any big investors in the project?
- Does the use of the software make sense?
- Do the founders have a reputable background?
These are just a few of the characteristics that you should look at. But once you start digging into these details, you will begin to see which projects could work for their intended purpose and which ones are probably scams.
This understanding will also allow you to assess the long-term viability of these different currencies and which ones will be more desirable in the future.
Tether is a cryptocurrency that wants to be the proxy for fiat currencies. So there is a Tether USD version, EUR version, etc. But each one is pegged to the value of the currency, so you can never make any money trading it.
It is purely to provide stable and liquid transactions. So one USD Tether will always be worth about $1.
If you didn't know this and bought a bunch of it, thinking that it's cheap compared to Bitcoin, you will tie up your money in an asset that will never appreciate. Sure, you won't lose money either, but you would have lost out on other opportunties.
So understand the nuances of each crypto, it's very important.
What are the Different Cryptocurrency Use Cases?
Almost every currency software has a different intended purpose and individual implementation, with inherent strengths and weaknesses.
It's like Windows vs Mac.
…or iOS vs Android.
Here are a few examples of the different types of cryptocurrencies and what they are designed to do. This is not an exhaustive list, just a sample.
Note: I don't necessarily support these currencies, I'm just using them as examples of the different use case niches within cryptocurrencies.
Worldwide Financial Transactions
Private Financial Transactions
Take a look at these different use cases and figure out which ones make the most sense to you. Then understand how each software implementation works and think about what will probably do well in the future.
How Do You Store Cryptocurrencies?
With fiat currency like US Dollars, you can store them at the bank or in your wallet. It's pretty straightforward.
But with digital currencies, there are a few wrinkles that you need to get your head around, but the idea is similar. Let's take a look at how cryptocurrency storage works.
You store your cryptocurrencies on the blockchain in a “wallet.” This is simply an address on the blockchain. It's like how the website address tradingheroes.com directs you to my website, on the internet.
Each wallet has a public address and a private address. The public address is the address that people send funds to. The private address is the “password” that you use to access and send your funds.
Never expose your private key until you are ready to spend your funds, otherwise you will probably lose all the money in your wallet.
Here's an example from a Bitcoin paper wallet:
Now that you understand the basics of cryptocurrency wallets, let's look at the different wallet options out there. Here are the different ways that you can store your loot:
- Online wallet: This is probably the easiest way to store your money. But it is also the least secure. So it's not a good long term storage solution, but it is fine for buying things and funding your trading accounts. Exchanges like Coinbase also have their own wallets built in.
- Mobile wallet: You can download a mobile app like Mycelium to store your spending money. It is more secure than an online wallet, but if your phone ever breaks or it gets hacked, everything in your wallet will be gone.
- Desktop wallet: Similar to a mobile app but just for desktop computers.
- Hardware device wallet: These are hardware devices that are built especially for storing cryptocurrency keys. They are safer than the options above, but they are still susceptible to the things that can damage all electronic devices.
- Paper wallet: You can also store your private key on paper, like in the picture above. This is the most hacker proof, but it is also the least convenient. If you are going to go this route, be sure to store them in a safe place (like a safety deposit box) and don't actually use paper. Use something like this to make sure that your money isn't lost to something as simple as a spilled beer.
Now we get to trading. Here are some of the exchanges that you can trade on.
Each exchange has it's own nuances and rules, so be sure you understand them before trading any significant amount of money. For example, you don't even have to setup an account at ShapeShift. It feels weird in the beginning, but after the first transaction, it makes total sense.
Cryptocurrency Tracking Apps
Before I wrap it up, you will probably need an app to track cryptocurrency prices on your phone. So here are a couple of apps that might work for you.
- Blockfolio: A simple app that allows you to add a watchlist and add trades so you can track your portfolio, ala stock trading apps. The most useful thing about this app is that it displays all currencies on your watchlist in the currency of your choice. Some apps insist on displaying the value in Bitcoin, which is annoying.
- Coincap: This app allows you to display currencies by market capitalization, volume and other ranking factors. They also have cool charts. Very useful for seeing what is being actively traded. Also displays prices in your currency of choice.
These apps are not for storing or trading currency. They are just to check the markets.
So that is the Trading Heroes Beginner's Guide to Trading Cryptocurrencies. I hope that it answered any questions that you may have had about trading currencies like Bitcoin or Ether.
There will be more detailed posts on specific currencies and how to do some of the things mentioned above.
If you have any more questions or comments, leave them below.
Disclaimer: Some links on this page are affiliate links. We do make a commission if you purchase through these links, but it does not cost you anything extra and we only promote products and services that we personally use and wholeheartedly believe in. A portion of the proceeds are donated to my charity partner.