In part 1 of our Trading 101 series, we discussed essential questions you need to ask yourself before you start trading. You learned how to determine your risk appetite and define your trading goals. Now, let’s have a look at the different cryptocurrencies.
As a crypto trader, one big question to answer is: “What cryptocurrencies will you be trading with?” Some traders only choose Bitcoin or Ethereum, other traders prefer a diversified portfolio to trade with a variety of coins to maximize their trading opportunities.
Whatever strategy you pick, it is essential that you understand the specifics of the respective type of coin and its blockchain platform to better evaluate where the price is likely to go.
How Cryptocurrencies Work – Technical Foundation
Cryptocurrencies are remarkable in many ways, yet their most distinctive feature is their decentralisation. Fiat currencies are managed by central banks that control how much money is issued which can affect the rate of inflation.
Most cryptos use a public blockchain where a large number of nodes utilize a consensus mechanism to decide on the validity of a transaction, thereby solving the double-spending problem. Confirmed transactions are encrypted using a hash algorithm and combined into blocks that contain a reference to all previous blocks, thereby creating a chain of blocks – a blockchain.
Cryptocurrencies are governed by their protocol which can foresee a maximum number of coins to be issued. For example, Bitcoin foresees a maximum of 21 million BTC to be issued. This “deflationary mechanism” is intended to avoid inflation as we know it from fiat currencies like USD and EUR.
The Different Types of Cryptocurrencies
Let us briefly describe the most common types of cryptos and their particularities and details:
Bitcoin was the inception of cryptocurrencies and had the goal of being a “digital electronic peer-to-peer cash system”, allowing for the direct transfer of money between users without the need for banks or intermediaries. Many other cryptos like Litecoin, Dash and Bitcoin Cash followed suit. All these coins serve the primary purpose of being a means of payment and money transfer with minimal transaction costs. However, the true usecase of Bitcoin is the store of value as alternative to gold rather than being used as a payment method.
Also entitled second generation blockchains, these cryptocurrencies are based on blockchain platforms with smart contract capability. Smart contracts allow the execution of decentralized applications (“dApps”) like decentralized exchanges or games.
The main purpose of the tokens of such a platform is to serve as a means of exchange between service providers and service consumers of dApps.
Bitcoin and other cryptocurrencies are only pseudonymous: the public can see the two wallet addresses between which a transaction took place, but the persons behind these wallets are not known. If the person is connected to a specific wallet, all transactions made through that wallet also become known, which means that bitcoin is only pseudonymous and not fully anonymous.
Privacy coins, on the other hand, ensure full anonymity and privacy of their users and their transactions by hiding the involved wallet addresses, e.g. through cryptographic methods or mixers. The most famous privacy coins are ZCash and Monero.
As most cryptos are highly volatile, a need for a cryptocurrency with minimal price fluctuations arose. Stablecoins avoid volatility e.g. by being pegged to a stable underlying asset like the US-Dollar or gold reserves. Stablecoins are popular with traders who wants to “park” their money during a bear market or while waiting for the next trading opportunity. The most common stablecoins – all backed by USD – are USDTether and USDCoin.
As an abbreviation for “alternative coins”, the term altcoin has originally described “any coin other than Bitcoin”. The most well-known altcoins were thus those in the top 10 to top 20 of all cryptocurrencies. However, due to the growing awareness of the top 10 coins, many of them have become independent coins in their own right, such as Ethereum, Ripple, Litecoin, Binance Coin, Cardano, etc. Technically, there are thousands of altcoins in existence, most of them being ERC-20-tokens.
This term describes all crypto assets issued as ERC-20-tokens, ERC-20 being a token standard for tokens issued on the Ethereum blockchain. These tokens commonly issued in ICOs/token offerings are typically used as a native means of exchange/payment (“utility tokens”) between service producers and consumers on the respective project platform. The most famous ERC-20-tokens are OmiseGo (OMG), Icon (ICX), Zilliqa (ZIL), VeChain (VET), Ox (ZRX) and Basic Attention Token (BAT).
How to find out which cryptocurrency you could trade
So far for the different types of coins but now what coin or coins matches your needs the best? Should you just stick the Bitcoin? Or should you trade with even more volatile altcoins in the hope of higher returns?
There is no one right answer. Rather, you should be aware of the specific coin you want to trade and know about its current developments.
- Is coin XYZ a decentralized or centralized coin?
- Does coin XYZ have a maximum number to be issued?
- Are there upcoming changes planned for its blockchain platform or protocol?
Factors influencing the cryptocurrencies price
Naturally, your trading decision will mainly revolve around expected price movements. However, it is impossible to predict how crypto prices move, since they are influenced by a multitude of factors such as:
- planned updates and milestones (e.g. like the launch of Ethereum 2.0 in Dec 2020)
- changes to the mining rewards (e.g. Bitcoin halving in May 2020)
- overall market sentiment on the financial markets
- economic development and interest rates
- milestones in crypto adoption (E.g. PayPal accepting BTC as payment)
- Correlation: when BTC goes up, so do most altcoins (usually)
Ultimately, deciding which cryptocurrencies to trade is similar to picking any other asset to invest in. Just like you would stay up to date on companies the shares of which you own, the same goes for cryptocurrencies you own and trade. Following the news and trends in the crypto-scene is not only interesting but can also really pay off.
Before trading with any cryptocurrency, make sure you understand its technical foundation and what type of coin it belongs to.
You look at the expected price developments and fundamentals of the asset and should only ever trade those coins which you really understand. Another important factor will be how strongly you believe in the respective project.
Knowing your risk appetite, trading goals and what cryptocurrency/ies you want to trade – the only question remains HOW. Stay tuned, as we will discuss the HOW TO in our next and final part 3 of our Trading 101 series!
This is not financial advice. Mentioning cryptocurrencies and trading pairs is not a recommendation to buy, sell, or participate in the associated network. We would like to encourage you to do your own research and invest at your own risk.