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This Bitcoin guide provides an overview of cryptocurrency trading today, what blockchain technology is, and the three best ways to buy cryptocurrencies such as Bitcoin (BTC) and Ethereum (ETH).
I first started writing about cryptocurrencies in 2013, and mined Bitcoin from my laptop that year. I also had the pleasure of being quoted by Minyanville for an analysis in my article titled, Bitcoin Arbitrage, Scalping Market Inefficiencies, and Currency Market Share Gradual Shift, which appeared on Yahoo Finance.
Fast-forward to today, and the market for alternative investments has grown exponentially. Cryptocurrencies have surged in popularity – thanks to the proliferation of financial technology (Fintech) that has fueled the adoption of non-bank financial products sought by investors, and powered by distributed ledger (blockchain) technology.
Blockchain Technology GrowthAccording to data from CB Insights, the amount of venture capital (VC) funding invested in fintech companies reached a new quarterly record in Q2 2017 of $5.19 billion, of which $232 million was invested in blockchain/Bitcoin companies.
Replacing the need for any trusted third party, blockchain technology is being used to power and verify cryptocurrency transactions belonging to public addresses (that hold bitcoin) controlled by private keys (used in bitcoin wallets) across decentralized networks.
According to CoinMarketCap, the cryptocurrency universe market capitalization hit a record all-time high of $813 billion on January 7th, 2018.
Cryptos are Now an Asset Class
Needless to say, Bitcoin’s place as an alternative digital asset among cryptocurrencies has become entrenched, despite likely headwinds it will continue to face as it evolves further. The U.S. Securities and Exchange Commission (SEC) announced in early August 2017 that certain Initial Coin Offerings (ICOs) – which use cryptocurrencies for financing – would be regulated as securities.
Shortly thereafter, the Chicago Board of Options Exchange (CBOE) followed, saying that it would be launching options on cryptocurrency derivatives, as investors are already looking at different ways to incorporate digital assets such as Bitcoin into their portfolios.
Many investors now recognize cryptocurrencies such as Bitcoin (BTC) and Ethereum (ETH) as asset classes. Therefore, knowing the three ways to trade this cryptocurrency can be useful for Bitcoin investors (and can be applicable to other cryptocurrencies).
Quick Note on Bitcoin Trading Costs
Trading costs, including any commissions and fees for trading cryptocurrencies like Bitcoin, can be substantial, reaching well over $1,000 per $1,000,000 worth of currency or more, compared to trading the same amount in fiat (non-digital) currencies in the foreign exchange (forex) market.
Fortunately, as Bitcoin trading continues to grow in popularity, competition is slowly bringing down trading costs and most exchanges offer similar pricing. That said, it is still important to check and make sure you understand how much you are being charged to buy or sell.
After introducing the three ways to buy Bitcoin, we will extend our exploration into the Pros and Cons of each method, and then provide a bottom line takeaway.
How to Buy Bitcoin: Three Ways
Here are the three ways you can buy Bitcoin:
- Buy Bitcoin the underlying - Buy from an online Bitcoin exchange such as eToro crypto and hold the actual Bitcoin currency in a digital wallet.
- Buy a Bitcoin CFD (Contract for Difference) - Buy the CFD derivative with an online forex broker.
- Buy a publicly listed Bitcoin security - Buy a market traded security related to Bitcoin such as GBTC and hold shares with an online stock broker.
(1) Buy Bitcoin Underlying Asset
Taking the first option listed above, which is to buy the underlying, you become the direct holder of the digital asset. Upon purchase, the cryptocurrency is sent to your bitcoin address or account (wallet) with the exchange. From there, you can transfer the crypotocurrency to any bitcoin address or wallet address using your private key that verifies you control ownership of the asset.
This responsibility to safeguard your private key which controls the digital asset also comes with some additional risks, as explained below. First, we will go over the positive sides of owning the underlying digital asset.
- You control the actual underlying digital asset.
- Most versatile option (can be transferred, sold, exchanged/converted).
- Can be secured with the use of a private key, compatible BIP39 recovery phrase (mnemonic) or by the exchange's wallet
- No thirdparty counter-party risk when the private key is generated and held in cold storage offline.
- Multiple payment wallet options available to store/transfer the asset.
- Private keys are unique to each address and must be safeguarded (your responsibility).
- Technical knowledge may be required to carry out operations.
- Lost private key or recovery phrases may equate to lost asset (unrecoverable).
- If the private key is stored at the exchange where you bought the Bitcoin, it could be hacked and your Bitcoin could be stolen from the exchange.
- Thirdparty wallets can get hacked or subject to malware/phishing and your Bitcoin can get stolen.
- If you keep the private key offline only (cold storage) and lose your private key and not able to recover it your Bitcoin is lost forever.
- You must remember your password or private key if you store your Bitcoin electronically or be sure you can recover your private key (the easier this is, the more prone your Bitcoin is to potential theft by hackers).
- Trading a CFD or derivative on Bitcoin negates the responsibility to safeguard any private keys or backup recovery phrases.
- Greater degree of leverage is usually offered on derivatives, so your cash margin can have more buying power (increased risk/reward).
- CFD/derivatives permit shorting by opening a selling position without first having a long (buy) position, for those looking to speculate on a decline in prices of the underlying.
- Brokers may be able to offer lower transaction fees, although spreads may be slightly wider or marked up, depending on the liquidity sources the brokerage uses.
- Spreads (trading cost) are usually wider compared to trading the underlying.
- Trades may be canceled or reversed in the event the broker finds fault in its systems (price, etc.) or if it finds a client violates their particular account agreement with the said broker (agreements vary).
- Clients rely on the creditworthiness of the online broker for managing any risk prudently and ensuring that it is well capitalized (less risk of going defunct).
- Margin trading means there is a chance of a negative balance occurring in the case of huge market volatility, a gap, or other Black Swan systemic event.
- In such cases, counterparty risk falls on the broker, which means if the broker declares bankruptcy, investors may suffer substantial losses and not receive priority among creditors.
- Trading a Bitcoin-related security that aims either to replicate the performance of the asset or act as a trust that holds Bitcoins where investors don’t need to hold private keys provides traders an alternative investment vehicle to buy and hold (long only).
- Doesn’t require safeguarding private keys
- Trades as a publicly listed security on exchange under exchange guidelines.
- The price of the security and the price of the underlying asset (Bitcoin) may vary, causing a tracking error, either due to fees or other differences in the portfolio construction methodology.
- The security may only be tradeable during exchange hours, and not 24 hours a day as is the case with Bitcoin.
- Volume of the traded security may be less than the available volume of the underlying asset (making it illiquid).
- Bid/ask spreads and other fees may be different than the cost of buying the underlying directly.
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For longterm investors who are willing to actively safeguard their Bitcoin, owning the underlying is clearly the way to go, but prudent steps must be taken to mitigate the risk of Bitcoin theft and/or loss of private keys (i.e., diversifying holdings across wallet/storage types, using two-factor authentication and strong passphrases).
Bitcoin Brokers to Consider
It is important investors realize not all exchanges and brokers that offer delivery of the underlying Bitcoin are created equal. Some firms have fallen victim to theft by hackers who have stolen Bitcoin belonging to clients whose money was held at the exchanges. Meanwhile, other Bitcoin exchanges have gone bankrupt (as in the case of Mt. Gox), as a result of fraud or mismanagement.
This counterparty risk and risk of loss from hackers is another reason why some investors don’t hold their Bitcoin on exchanges directly but transfer it to an independent wallet (which carries its own risks, as outlined above).
Nonetheless, choosing an exchange that meets your needs is important. For US-based investors, Coinbase is one of the leading exchanges to offer cryptocurrency trading on Bitcoin, and recently integrated with Fidelity Investments so Fidelity clients can see their Coinbase balances from their Fidelity brokerage accounts.
For non-US clients, Swissquote – a major forex brokerage/bank in Switzerland – has teamed up with Bitstamp to offer actual deliverable Bitcoin. And, Japan-based GMO Click Holdings, another one of the largest forex brokers by volume, has launched its GMO Coin offering for Bitcoin investors. Last but not least, eToro Crypto is another viable option for cryptocurrency investors who want to purchase bitcoin.
(2) Buy Bitcoin as a CFD
Active traders looking to speculate on Bitcoin over the short or medium term may find that trading CFD/derivatives on Bitcoin using an online forex broker will provide them with 24-hour trading, potentially lower margin, and the ability to go either long or short. Because of counter-party risk, choosing a broker to trade bitcoin is just as important as finding one with the best trading tools or commission rates.
Forex Brokers Offering Bitcoin CFDs to Consider
To trade Bitcoin and other cryptocurrency using CFDs through a forex broker, view our guide of the Best Forex Brokers to Buy Bitcoin.
Here's an example of trading bitcoin (BTC) and cryptocurrencies on eToro's web platform:
(3) Buy Bitcoin-Related Securities (ETFs, ETPs, etc.)
One good example of a Bitcoin-related security would be the Grayscale Bitcoin Trust (OTC: GBTC). The Grayscale Bitcoin Trust is backed by one of the largest venture capital firms that specialize in Bitcoin and is affiliated with a substantial group of related businesses headed by Barry Silbert – a prominent Bitcoin investor and industry figure.
For stock market investors, investing in Bitcoin indirectly through a listed security such as an ETF, ETP, or trust may be suitable for those looking at taking a passive position. Active traders might find the limited trading hours and potential lack of volume a limiting factor that could hinder their trading. Overall, using listed securities that invest, track, or hold Bitcoin can be a viable alternative to diversify away from the risks of margin trading or safeguarding private keys when buying the underlying.
That said, events such as hard forks can pose issues for Bitcoin-related trusts such as GBTC, depending on how such events are handled and the degree of any proceeds distributions and administrative fees. For that reason and the pros/cons noted above, Bitcoin-related securities would not be my first choice when looking at the three ways to trade this asset.
Stock Brokers that Offer Bitcoin-Related Securities and/or Futures Trading
To trade Bitcoin related securities or futures, you are likely going to be a US citizen residing the United States. See this guide from our sister site StockBrokers.com, the Best Online Brokers.
Here's an example of trading online with the TD Ameritrade's thinkorswim platform:
There are three ways to trade (buy/sell) cryptocurrencies such as Bitcoin (BTC). Each way has its own upsides and downsides. As the cryptocurrency market continues to evolve, access to trading crypto will expand and become easier.
In the end, what matters most is using an exchange / online broker that you can trust. The safety of your funds is, first and foremost, most important. If the exchange or offer looks questionable, don't invest.
How can I purchase Bitcoin?
You must open a trading account with a broker that offers bitcoin, such as individual forex brokers or bitcoin exchanges.
Decentralized Exchanges (DEXs) are not an ideal place to trade due to the lack of liquidity and wide spreads. Also, peer-2-peer trading is inadvisable as it can be illegal in certain jurisdictions, in addition to posing risks of fraud when the seller is unknown.
Choosing a regulated bitcoin broker offers the best chance to minimize fraud while paying fewer commissions and a tighter spread. Then, you can keep your bitcoin there or move it into your self-custodial wallet (i.e., hot or cold storage).
Where is the best place to buy Bitcoin?
While there are a few different ways to buy bitcoin, such as peer-2-peer, or using a non-custodial decentralized exchange (DEX), the most preferred method is through a regulated broker.
You can also speculate on bitcoin using CFDs with a forex broker. In all cases, it is essential to use a regulated broker to minimize any chance of fraud, while maximizing your opportunity to receive a fair price while paying regular commissions and spreads, when purchasing bitcoin.
Can you lose money buying Bitcoin?
You can lose (or make) money fast by buying bitcoin because the price of bitcoin relative to other currencies such as the US Dollar is highly volatile.
Bitcoin behaves like a scarce commodity and has been compared to gold and other volatile assets. Despite its blockchain technology being around for over a decade, bitcoin has still not yet been broadly adopted, due to its complexity as a next-generation financial product.
Therefore, any investment into bitcoin should be considered the most speculative use of risk capital, as you can lose money buying bitcoin.
Is trading cryptocurrency legal?
In some jurisdictions, cryptocurrency such as bitcoin may be banned or illegal to purchase, trade, or own, while in other countries, it may be perfectly legal. For example, in the US, it is legal to buy cryptocurrency, but the seller must be a licensed money transmitter and registered with FinCEN as a Money Service Business (MSB).
Cryptocurrency is a new asset type that has emerged over the last decade. Bitcoin continues to cause changes to how laws are interpreted, in addition to new rules and proposals by lawmakers and regulators surrounding digital assets.
Do I have to pay taxes on bitcoin profits?
While certain countries may classify cryptocurrency differently and may tax it according to how it is categorized, you must pay taxes on your gains from bitcoin. Also, taxes would be due on the value at the time of receipt if you were paid income in the form of cryptocurrency, such as bitcoin.
Since we cannot offer tax advice, it is best to consult an accountant to determine whether any de minimus applies for smaller amounts. For example, bitcoin is taxed like property in the US. And, while tax laws vary depending on the country where you reside, bitcoin must not be used for illegal tax evasion of cryptocurrency earnings.
What are private keys in bitcoin?
Cryptocurrency, such as bitcoin, are each controlled by unique private keys, which are extremely large unique secret integers (numbers). These secret private keys are used in public-key cryptography to sign (authorize) transactions and to derive each unique public address (where the bitcoins are stored).
Since no one can reset your private key, managing your private keys comes with a lot of responsibility. Just like having hard cash in your pocket can be lost, so too can private keys be lost and are unrecoverable. Lost keys can result in a total loss of your cryptocurrency.
Thankfully, there are best practices in place for securely deriving private keys, as well as creating backups. Whether via hardware wallets or by writing down mnemonic recovery phrases, which are (BIP 39 compliant) word representations (encodings) of your large secret integer used to derive your wallets, cryptocurrency can be safely secured (and provided that the software is trusted and cryptographically-secure).
How can I securely custody my own bitcoin private keys?
To secure your bitcoin, you must choose a hot or cold non-custodial wallet. You must be sure you trust the wallet provider implicitly and have done enough research to be sure it is cryptographically-secure from a bonafide technology provider. After you download the software from their official site, you will be able to custody your bitcoin private keys, including any other supported cryptocurrency.
Most importantly, be sure to learn how to properly back up your bitcoin wallet, using an industry-standard recovery phrase (BIP 39) that gets generated directly from your wallet. Such recovery phrases enable you to restore your wallet (and should be kept offline for security against hackers).
While bitcoin wallet software can be complex, be sure to read all instructions and transact only small amounts first before being sure you know what you are doing, as some errors can be fatal and cause an irreversible loss of your money.
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Forex Risk Disclaimer
"There is a very high degree of risk involved in trading securities. With respect to margin-based foreign exchange trading, off-exchange derivatives, and cryptocurrencies, there is considerable exposure to risk, including but not limited to, leverage, creditworthiness, limited regulatory protection and market volatility that may substantially affect the price, or liquidity of a currency or related instrument. It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable, or that they will not result in losses." Learn more.