Should You Invest in Cryptocurrencies?

#8 — What are the differences between stocks and cryptocurrencies ? How is the price defined?

You don’t need to start investing millions, you can even start with $100

Are you wondering whether you should or should not invest money in cryptocurrencies? I was asking myself the same question. In order to take this decision, I had to understand what are the differences between stocks and cryptocurrencies and how the price of the cryptocurrencies is defined.

This article will not tell you if you should invest or not in cryptocurrency, it will give you the keys to take your decision.

This article is part of my Learning challenge where I learn about one topic each month. As you can imagine, this month, I was learning about trading & cryptocurrencies. I based this studies on a book and a few article and ended up investing 1000€ on cryptocurrencies. Click here, if you want to know more about my methodology.

Cryptocurrencies vs Stocks

Here are the main differences between cryptocurrency market and the stock market. I am not saying one is better than the other one, it depends on your availability, the amount you want to spend and the risk you can afford.

Volatility

The volatility is how big the prices of a currency or a stock fluctuate. Bitcoin volatility is getting lower and lower, it’s as volatile as oil price. But not all the altcoins (other cryptocurrencies) are like this. So if you don’t like volatility go for bitcoin or go for the stock market which is usually less volatile than altcoins.
Read more about volatility in the article below.

Intermediary

When you buy stocks you usually have the website where you buy your stocks and hold them and then the exchange company (where the stocks can be traded). Whereas in cryptocurrencies you sell it directly in an exchange but you have many exchanges for the same currency which means you have different prices for every cryptocurrency.

Regulations

The stock market is highly regulated, the government can get the data of your profits easily. Insider trading is forbidden. Whereas in cryptocurrency you don’t have much regulation (YET! 😅). Some governments already started asking some exchanges to expose their customer’s data to the tax office. If you are not convinced yet check the news below.

Security

The trading websites and exchanges have never been hacked and since they are linked to your name and identity it’s not that easy to hack or do a fishing attack on someone. Whereas in cryptocurrencies market if you lose your password or your email gets hacked it’s easy for someone to steal your coins. Also, some exchange websites has been hacked 😶(Mt.Gox, Bitfinex, Bitstamp, see more in the article below) in the past so it’s dangerous to keep your coins in those websites.

Business knowledge

The price of the stocks are tightly coupled to the results of a company. If they are good the price usually grow, and if they are bad they go down. So to better predict the evolution of the price you should understand the company health, its wealth and you should be able to read their financial reports and results. With cryptocurrencies you don’t really need this business knowledge, the most important is that the cryptocurrencies always meet their deadlines otherwise the price crashes!

Technical knowledge

To trade in stocks you don’t really need any technical knowledge whereas in cryptocurrency it’s better to understand what is the wallet and what is the coin you are investing in.

Availability

The stock market only opens during the weekdays and from 9 am to 6 pm so you cannot manage your stocks outside the mentioned hours. Whereas Cryptocurrency markets never stop, they open 24h and 7days.

Centralization

The stocks market evolution depends a lot on the central banks which define the interest rates, and makes also the currency price evolve. Whereas the cryptocurrencies are decentralized. Be careful though most of the exchange websites are centralized, so if it goes down, or it’s being hacked, or your country bans it, you cannot do anything. The good news is that some companies are creating some decentralized exchanges and it is unstoppable.

Fees

In the stock market, you usually pay transaction fees but also annual fees for each stock you are holding. With cryptocurrencies, you have to pay fees for transactions and for transfer but in some exchanges there are no fees. So always check the fees before starting anything.

Scripting

Since the stock market has a few intermediaries it’s not very programmer-friendly. Whereas in cryptocurrencies most of exchange website has an API (Application Programming Interface) which can be used by anyone, to build apps, programs, scripts, or bots 🤖. If you don’t know how to program there are also bots you can pay for, or some free open source ones very easy to use and to set up. If you are interested, check those two open source ones:

Minimum investment required

To get started with stocks it’s better to invest at least 5000 € otherwise you will never be able to see your portfolio growing or making good profits. Whereas in cryptocurrency if you had invested 100 € in 2011 you would be a millionaire today, so why not starting with only 100 € to give it a try?

Growth

In 2017, the growth of the NASDAQ was around 30% whereas bitcoin growth was about 1230%. I think, there is no comparison. Also, you have other cryptocurrencies like NEO with even bigger growth, in 2017 NEO had a growth around 69000% 😮.

This is what homer thinks about stocks 😂😂 what would he think about cryptocurrencies?

Dividends

Some stocks can give dividends and it’s something really great. There is also something similar with Cryptocurrencies. Some of them use something called “Proof of Stake” and they give a reward, a bit like dividends. So keep this in mind!

Risks and rewards

There is a strong link between risks and rewards, the more you risk the more you can get rewarded but also the more you can lose. So what everyone adviced me and what I can advice you is the following:

Only invest what you can afford to lose

So as you can see there are many pros and cons for both, so if you want to do it well, better invest in both! In my case, I put 1000 € and I am ok to lose them all. As I said before, 1000 € it’s nothing compared to a master degree which cost 19 000 €. Moreover, it’s worth losing it to learn how all this works. Also, only invest money you don’t need now.

For the people who think Cryptocurrencies are a bubble which will explode I invite you to read this.

Be ready, psychologically

When you start trading you will quickly be very addicted: checking the price all the time to get your dopamine or wanting to invest more. Always keep this in mind: after setting a strategy (we will see later how), stick to it. Never forget one thing, you may lose all the money invested at the end. That is why before investing you should accept this fact: you may lose all your investment 😱. The good news is you may also multiply your investment by 10 or even more.

Also, you may be very impacted emotionally by the growth or the decreases. So be ready for this. If you have a clear strategy it will not happen. A trick is to invest with a group of friend so you can help each other to calm down 😁.

I have many of my friends who started to feel bad, frustrated or to start to panic, it’s normal but you have to fight and stay strong 😅 to avoid this happening.

I invite you to read this article of someone who had a similar approach to mine and also had these problems: https://medium.com/swlh/how-i-turned-my-summer-into-a-cryptocurrency-investing-course-168c8f1e5917

Cryptocurrency trading games

If you are scared of investing real money and you want to give a try I invite you to do it with fake money, there are a few online trading games:

How is the price defined

Now let’s talk about the most important basic of trading: how the price is defined, why is it sometimes growing or decreasing? how do you read a graph?

Let’s start with a very simple example. There are 3 people: Alex, John, and Jane in a COIN market.

  • Alex wants to sell 1 COIN for 1.00 €
  • John wants to sell 2 COIN for 1.10 €
  • Jane wants to buy 2 COIN for 0.90 €

When you want to buy something you always want to buy as cheap as possible, and when you want to sell, you want to sell as high as possible.

Let’s imagine I want to buy 2 COINS right now, I will buy the cheapest coin I can, which means I will buy 1 COIN from Alex for 1.00 € and 1 COIN from John for 1.10 €. The price of the market will then be 1.10 € because it’s the last transaction price.

Imagine now I want to sell my 2 COINS in the market and there is only Jane who wants to buy it for 0.90 €, I will sell my 2 COINS to her and the price of the market will now be 0.90 €.

It is simple right? 🙂 that’s why people say that the price is regulated by supply and demand. If for example, no one wants to buy, then there is no price, the COIN will not be worth anything!

Now, let’s see how it is in GDAX, one of the exchange platforms.

BTC/EUR market from GDAX

You can see here on the left the “ORDER BOOK”, it represents the amount of BTC people wants to buy (in green) and sell (in red). Like in the previous example, the prices in red from sellers are higher, than the market price, and the ones in green are lower.

And then on the right, you can see the history of trades and you can see the latest trade (on top) is equal to the price of the market.

In the middle, you can see the price charts with candles and, in this case, each candle represents 6h period. You can change the period of the candle in the interface. Here is how to read a candle:

  • If it’s green it’s an increase in the period, if it’s red it’s a decrease.
  • The big part represents the price at the start and end of the period
  • The line represents the minimum and the maximum during the period
The open and the close are the start and the end of the period

You can use these candles to analyze the evolution of the coin, you can see that in this article. But it’s important at least to understand what it means.

Now we saw how the price can evolve let’s talk about the two types of orders:

  • Market order: you buy/sell now taking orders from the order book for the amount you want, you don’t control the price of the purchase of this order.
  • Limit order: you set a price of the purchase (lower than the market price) or a price of sales (higher than the market price) and when someone will buy or sell, your order may pass.

In our previous example with COIN, I was making a Market order and Alex, John, and Jane had Limit orders because they had a defined price. Let’s imagine 100 people were selling each 1 COIN at a price of 1.05 € maybe the sale order of John for 2 COIN at 1.10 € will never pass because it would require that 100 COIN at a price of 1.05 € would pass first.

So remember one thing: when you want a very fixed price only pass a limit order. If you want your order to pass right now make a market order. Note that some exchanges put more fees for Market order than Limit order. For example, in GDAX you pay 0% of fees on limit orders (called maker fees) and 0.25% of fees in market orders (called taker fees).

Let’s now talk about the depth chart which illustrates the ORDER BOOK. The more orders you have in it, the more liquid is the market, which means it will be more stable. You will see below why.

When this screenshot was taken the market price was 12727€ for 1 BTC. Let’s imagine I have a lot of BTC and EUR in my account and describe two cases:

  • I want to sell around 49 BTC to make a total around 609 000 € (yeah that’s a lot), if I do it at the market price, as a taker. The price of 1 BTC will decrease to 12 160€ you can guess it from the graph above.
  • If Instead, I want to buy for 609 000 € (follow the blue line I made in the graph) at the market price, I will get around 47 BTC. The price of 1 BTC will increase and will be around 13 075€ for 1 BTC.

With this graph you can predict in the next minutes how can the market go. It’s a very good one. Also, you can see that the more the market is liquid (more buy and sell limit orders placed) the less volatile it is. Depending on the exchange website or the exchange pair you can have less liquidity and the price can fluctuate a lot. So be careful choosing the website you are going to use, use the one with more users. I explain how to wisely choose your exchange in this step by step guide.

Some vocabulary

Now let’s define some vocabulary you need to know, you already saw some of them above but let’s put them all here at the same place in case you forgot something while reading.

  • Volatility — The degree of variation of a trading price series over time.
  • Liquidity — The degree to which an asset can be quickly bought or sold in the market without affecting the asset’s price, so the more liquid is a market, the less volatile it is!
  • Order — The given instruction (to buy or sell) to the exchange or a broker.
  • Market order — Order (buy or sell) to execute now with a defined amount using the current market prices.
  • Limit order — Order (buy or sell) with a defined price and a defined amount.
  • Taker — When you make a market order you are a market taker
  • Maker — When you make a limit order you are a market maker, and you make the market less volatile. That is why some exchanges put fewer fees for market makers.
  • Bid — What people want to buy, what you can sell
  • Ask — What people want to sell, what you can buy, the price of ask is always higher than the price of the bid.
  • Resistance — A line (or a price range), in a trading chart, in a period of time, where the market price will struggle not to go above. If it goes above the resistance line, it usually starts rising a lot until the next resistance.
  • Support — A line (or a price range), in a trading chart, in a period of time, where the price market will struggle not to go below. If it goes below the support line, it usually falls very fast until the next support.
  • Consolidation — When the market decreases.
  • Correction — When the market falls a lot.
  • Bullish — When the price is rising
  • Bearish — When the price is falling
  • Trend — General direction of the market
  • Fiat — Nonelectronic currency like the dollar, euro, yen.
  • Portfolio — Pool of different investments
  • Wallet — The address where you hold your cryptocurrency
  • Exchange — A website where people are connected to buy and sell their cryptocurrencies
  • ICO — Initial Coin Offering, it’s like the IPO of the Cryptocurrency world, a new way to raise founds by selling coins/tokens.
  • Token — A coin, but not necessarly used for payement.
  • Hard Fork — When someone makes a cryptocurrency out of an existing one, by doing a hard fork it keeps the transaction history of the previous cryptocurrency until the moment they do the hard fork. The most famous one is Bitcoin Cash. It means if you had 1 BTC in your bitcoin wallet just before the fork, you would get 1 BCH at the same address. For free!
  • Market capitalization = price per coin * circulating supply (number of coins in the market)
  • HODL — An internet meme coming from a typo “Hold” 😁, it refers to the fact that no matter how the price is falling, just hold it, don’t sell it. Here is the original post where HODL was born — https://bitcointalk.org/index.php?topic=375643.0
  • FOMO — Fear Of Missing Out 😵 — The bad habit is to buy something because it already raised a lot, and you are scared the price will never decrease because you have the FOMO.
  • FUD — Fear, Uncertainty and, Doubt 😱 — In the internet, people say “Stop FUDding” it means stop selling because of the fear. It is usually what is happening when the price decreases, everyone has the doubt and sells. It goes against the HODL principle.
The rule is simple, no matter what, just HODL

What’s next?

This article is part of my Learning Challenge about Trading & Cryptocurencies. Like this one I made 4 others article related to the topic.


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