Over the past few years, cryptocurrencies have been making a splash in the financial ecosystem.
Every day we can read in the news how easy it is to invest a small sum of money and yet generate a stellar profit. Just remember the story about a 19-year old billionaire who invested $1000 and now he has 401 bitcoins worth $3.4 million.
One of the most effective ways to explain what cryptocurrencies are and how they work is to compare them with forex trading, a practice most of the traders are already familiar with.
Here are a few facts about cryptocurrencies and forex you need to know before you choose where to invest.
What is Forex Trading?
Forex or the foreign exchange market is the place where people can sell, buy, or exchange currencies. The idea behind it is pretty simple- you want to buy a currency at one price and sell it at a higher price in order to make a profit.
Currencies are always grouped into pairs to show the exchange rate between them. Of course, the price of one currency is always determined by another currency.
Some of the most commonly traded forex pairs, also known as major pairs are EUR/USD, EUR/GBP, and USD/JPY, and USD/CHF.
However, you can also trade some minor currencies, known as exotics, such as MXN (the Mexican pesos), PLN (the Polish zloty), RSD (the Serbian dinar) or the NOK (the Norwegian krone).
The Benefits of Forex Trading
With the rise of forex trading platforms, today everyone can get involved in trading currencies. Here are a few reasons why you should make this sort of investment:
Fluidity
Forex is the largest and definitely the most liquid financial market. This is the market with many bids, low spreads, and low volatility. Given the fact that there are numerous buyers and sellers, it is pretty easy to execute a trade fast and at a desirable price.
24-hour trading liquidity
Forex is the over-the-counter market, meaning that investors can instantly take actions according to currency fluctuations caused by numerous economic, political or social events. Most importantly, this market is open 24 hours a day, 5 days a week. There are 4 major trading sections each day, matching the opening hours of banks in New York, London, Tokyo, and Sydney.
High leverage
Currency movements are measured in pips, the tiniest variations in the currency price. However, since these fluctuations are negligible, currency transactions need to be conducted in larger amounts, enabling you to turn these small sums of money into significant profits.
But, this puts your money at risk. For example, when you carry out some larger transactions, even the tiniest variation in the currency price can bring you either notable profits or loss.
What’s also great about forex is that it gives you the freedom to choose a proper leverage sum, in accordance with your financial health and preferences.
Accessibility
Due to the volatility of the market, you can invest a small sum of money and generate a huge ROI. For instance, you can start with a deposit of $100. For small-size and inexperienced traders, this is probably the most significant feature of forex trading.
Major Drawbacks of Forex
Even though forex has been around for quite some time now and it’s considered pretty safe, investing in it still comes at a price. Before you get involved in it, you need to learn the basics of forex trading and understand its major drawbacks. Here are some of them:
- High leverage can also be very dangerous. Namely, if a broker offers a leverage ratio of 50:1, meaning that you need to have only $1 to take a trade valued at $50. Even though this may mean making money fast, you need to know that your losses can be multiplied, as well.
- Insufficient transparency. This market is dominated by brokerage firms, meaning that you’re actually trading against pros. The mere fact that forex is a broker-driven market means that it lacks enough transparency and that a participant may not be able to control how their trade order is completed. In other words, you may not access the best quoted price.
- Complex price determination. The constant fluctuations of exchange rates are affected by numerous reasons, including geopolitical and macroeconomic factors. In this case, you may lose your money and not be able to do anything about it.
- The risk of scammers. One of the major disadvantages of the forex market is the fact that it is prone to scams. Therefore, to make sure your transactions go smoothly, you need to choose a reliable broker.
What is Bitcoin?
Bitcoin is a relatively new currency, created in 2009 by an unknown individual under the alias Satoshi Nakamoto. The idea behind this entire project was to develop a new means of exchange that would function independently of any central authority, such as banks. It could be transferred electronically, in a safe and easily verifiable way.
Just like any other currency, bitcoin is used to pay for goods or services. In that sense, it resembles conventional euros, dollars, or yens that can also be traded online.
It can be used to book a hotel room on Expedia, deposit funds into your Microsoft account, or shop on Overstock. However, what sets it apart from traditional currencies is the fact that there is no government behind creating or trading it, meaning that it derives its value from the number of users buying it.
Some of the major characteristics of bitcoin are:
- Decentralization. There is no institution that controls the bitcoin network. Namely, it is maintained by volunteer coders and run by an open network of dedicated computers all across the globe. This is exactly what hooks numerous users that are uncomfortable with government institutions and banks controlling their money.
- The open source code is an immensely important feature of Bitcoin. Using advanced mathematical algorithms, it is supposed to mitigate the risks of illegal creation of bitcoins.
- User anonymity. Privacy protection has become synonymous with Bitcoin. And, the way it works is logical- all relevant information about a user is stored publicly, without revealing their identity.
- Private keys. Each Bitcoin trader needs to own a private key, usually in a form of a password. These keys are used to confirm their owner’s identity and help them complete transactions. Now, private keys can be saved in so-called wallet files.
- Wallets is a form of a cloud storage, used to identify their users. Even though their primary purpose is to prevent the bitcoin theft, they are still not regulated well and are prone to hacking.
- According to Investopedia, the blockchain is “a public distributed ledger of all bitcoin transactions that are stored in groups known as blocks.” As new bitcoin transactions keep rising, the blockchain grows, as well.
- Miners are users that make the bitcoin landscape more reliable. Their aim is to conduct extremely difficult mathematical tasks in order to make new Bitcoin.
The Major Disadvantages of Bitcoin
Even though cryptocurrencies may be a lucrative opportunity for making money, trading in them is still pretty risky. Here are some of the major problems you may face when investing in bitcoin.
Volatility
Bitcoin is famous for its volatility. And, that can be really great given the fact that that’s how traders make money quickly. However, since the number of bitcoins is limited and the demand for them keeps rising, this market has become too volatile.
Namely, the price of a bitcoin can skyrocket or plummet a few times per day. This means not only making easy money, but also losing it fast.
Security risks
One of the major drawbacks of bitcoin is security risks. Namely, even though bitcoin units cannot be duplicated, they’re still vulnerable to theft. Hackers are well familiar with the weaknesses of this system and use them to steal bitcoin for their own purposes.
No refunds
All credit card companies and traditional online payment processors have a standardized policy for refunds. However, that doesn’t exist in the world of cryptocurrencies. For example, if you make a purchase and the seller doesn’t deliver the product, you cannot ask for a refund through bitcoin.
Overview
Even though there are certain similarities between forex and bitcoin, comparing them is similar to comparing apples and oranges. They are two completely different forms of investment and they need to be approached this way.
To choose the trading option that meets your needs, you need to do your research and understand the basics of both markets. Most importantly, you need to stay on top of your investments, keep track of the latest changes, and always try to make informed decisions.
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