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What Is Spot Trading in Crypto?

May 13, 2022

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What Is the Spot Market?

Although “spot market” may sound intimidating and enigmatic for beginners, it’s actually one of the most popular types of trading out there. It is widely present on the biggest stock exchanges in the world like NASDAQ. The spot market definition would be “buying an asset from a seller on a public platform in exchange for fiat currency or other mediums”.

In spot markets, you make payments upfront and can only trade assets you actually possess (the other option, which involves leverage, we’ll discuss later). Because of this, most deals are fulfilled on the spot (hence the name) and the delivery of the asset is immediate. The latter, however, may not be the case in all spot markets: depending on the asset, it may be delivered according to the T+2 model (the trade day plus 2 business days).

Spot markets exist for all types of assets, from bonds to shares and beyond. However, spot trading crypto can be more profitable. Crypto provides you with more opportunities on the spot market than regular assets because of the inherent volatility of the currency. The feature that harms the long-term investors is great for traders who are willing to bet on the short-term price fluctuations.

Understanding Crypto Spot Trading

To understand what is spot trading, you need to remember the golden rule of trading: buying an asset as cheap as possible and selling it at a higher price.

You can also sell an asset and then buy it back for a lower price. This practice is called shorting and is more advanced. To dive deeper in shorting, check out this article (https://freewallet.org/blog/how-to-short-bitcoin/)

Alternatively, you can go long with your asset, selling it after months or years with a significant price increase, but this is not so much trading as investing.

Every spot market consists of 3 things:

Buyers, who offer the bid price – the max amount they are willing to spend on the asset. Bid prices are shown in green;
Sellers, who offer the asking price – the lowest amount they are willing to sell for. Ask prices are shown in red;
Order book – the list of all prices. This list is a) divided into bid and ask categories; b) sorted from best to worst price; c) quoted by 1 BTC (in a hypothetical BTC/ETH pair).

More on this topic: https://freewallet.org/blog/trading-terms/

Between the lowest bid price and the highest asking price, there is a magical site called “spread”. By putting your order in the spread, you guarantee its immediate execution.

Spot Trading vs. Futures Trading: The Main Differences

A future is a contract with a certain expiration date set in the future. When this date passes, all obligations are fulfilled and the contract renews with a new ticker. There are also perpetual futures contracts (however bizarre this may sound): these don’t have an expiration date.

Unlike the futures market, spot trading doesn’t allow leverage. Leverage is essentially borrowing money with interest to trade. This may greatly increase your profit: if you trade with 10X leverage and the price goes down 5%, your gain is 50%. However, trading in the futures market comes with a greater risk. If the price goes up 5%, then your loss is 50%. You can use 10X, 25X, even 50X leverage, so one bet on the futures market may be extremely profitable.

If your loss is greater than your margin, then you are liquidated and cannot trade anymore. Due to this, beginners are usually advised to trade with a 2X or even 1X margin to avoid being liquidated. It’s fairly easy to start gambling when you see such high potential profits, so it’s better to start out with small sums and practice humility: be satisfied with your current profit.

To find out more about margin trading in crypto: https://freewallet.org/blog/margin-trading-explained/

The futures market is great if you want to hedge against spot traders or lock in your profits against volatility.

The worst thing that can happen in the futures market is the absence of the counterparty at the expiration date. To protect traders against this risk, exchange platforms employ two strategies:

Performance bond – an initial margin large enough to cover all obligations;
Maintenance margin – requiring users to keep on their accounts the minimum required amount to cover all open positions.

At the end of the day, the two types of markets have one big similarity: you have to predict the price fluctuation correctly to gain. After that, it’s just a matter of risk and reward.

Where to Trade the Crypto Spot Market: OTCs, CEXs, DEXs

Over-the-Counter Trading / Peer-to-Peer

OTC trading is exchanging directly with other traders through calls or messages. The main danger of this is not knowing who is behind the screen: a scammer or a trustworthy dealer.

But this type of trading may be useful for large orders. If you place a way too large order on the exchange platform, part of it is automatically filled with the next best price. This is called slippage, and it doesn’t happen with OTC orders.

Centralized Exchanges (CEXs)

The exchange platforms function as sheriffs in the Wild West world of crypto. They check traders for reliability, manage regulatory compliance and simplify the trading process. In exchange, they extract a certain fee from every deal. At the end of the day, everyone benefits. To trade on such a platform, you need to seal your account with fiat or cryptocurrency to trade.

Decentralized Exchanges (DEXs)

DEXs provide you with the same guarantees, but on the basis of Blockchain. Because of this, they are mostly present in crypto trading. It is a bit similar to OTC: you do not need to create an account on the exchange platform or transfer money to it, the asset goes directly to your buyer via smart contracts.

DEX gives you more freedom, but simultaneously provides less security because the customer verification is less stern.

The Advantages of Spot Markets

The pros of spot markets mostly have to do with convenience and simplicity.

The price of the asset itself is much more transparent, since it derives only from the current supply and demand on the market;
Since you trade without the margin and only with your own assets, there is no risk of being liquidated;
You do not have to worry about time: as was mentioned in the very beginning, buying and selling an asset takes seconds and you can take a break whenever you feel like it.

The Disadvantages of Spot Markets

Spot trading is limited by nature, that’s why some traders tend to avoid it:

Since you cannot trade with a margin, your potential gain is minimized;
When trading physical commodities, you burden yourself with obligatory physical delivery. In futures trading, this problem can be solved by cash settlement or just dealing with it when the expiration date comes. And generally it doesn’t really apply to cryptocurrency as a digital asset

Conclusion

So what is the spot market? A great place to start, although experienced traders may find them insufficient for their demands. If you want to be successful in this type of trading, as with any other, you have to immerse yourself in features of technical analysis and general info about the state of the market. After constantly following the related news for some time you start recognizing certain patterns (and develop a sixth sense).

But remember this: with trading, as with any other type of financial activity, you will not get profit every time. And it’s OK.

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