Cryptocurrency trading has become incredibly popular in recent years, especially among younger traders. Few are aware of cryptocurrency CFDs and the fact they can be traded in a regulated environment.
Many cryptocurrency traders get their first taste of the financial markets when they buy or trade on crypto exchanges like Binance, Coinbase or Kraken. Cryptocurrencies are a highly volatile asset class, making them attractive to speculators, particularly scalpers and day traders. Cryptocurrencies were predominantly exchange-traded products. However, in recent years, popular exchanges have developed their services to offer leveraged products, such as spot margin trading, futures and options.
Naturally, crypto traders gravitate towards the margin trading products offered by cryptocurrency exchanges, except that’s not the only way to trade crypto with leverage. This article explores the advantages of trading cryptocurrency contracts for difference compared to classic crypto exchange platforms.
A contract for difference, or more commonly referred to as a CFD, is a financial derivative. CFDs are ordinarily offered with leverage to enter short-term trades, either long or short, on various financial markets without owning the underlying asset. CFDs are used to speculate on all manner of financial markets, such as currency pairs, stocks, commodities, indices, cryptocurrencies, even other derivatives, like futures and options.
A CFD is merely an agreement between a broker and a trader. CFDs are always settled in cash and do not give the option to buy the underlying asset. Therefore, neither party needs to own the underlying asset.
Traders use CFDs to speculate on the price of an underlying asset. When the contract is closed, the parties settle the difference between the opening price and closing price. If the trader is profitable, the broker pays the difference between the opening and closing prices. If the trader isn’t profitable, they pay the difference to the broker, hence the name, contract for difference.
Providing CFDs is a regulated activity, and laws vary depending on the jurisdiction. In general, brokers require a license from a financial authority to provide CFDs. In most countries, the license to provide forex trading also encompasses other products, such as precious metals, cryptocurrencies and sometimes CFDs. That’s why you’ll typically see forex brokers listing currency pairs, commodities, stocks and cryptocurrency pairs in one platform.
You might be wondering why you should trade cryptocurrencies with a company that specialises in forex rather than one specialising in crypto. This section describes key differences between CFD brokers and cryptocurrency exchange platforms.
Cryptocurrency exchanges function very similarly to a stock exchange; it’s a venue consisting of buyers, sellers and market makers. Stock exchanges are highly regulated. Any products listed on a stock exchange are vetted thoroughly, companies and operators are subject to strict oversights, and all transactions are reported to authorities and regulators. None of this happens with cryptocurrency exchanges.
Regulated forex and CFD brokers must pass strict due diligence before any regulator grants a license. Regulators check to see if the owners and managers are fit and proper, ensuring they have clean criminal records and verify they have the qualifications to run the business.
A regulator will also check if the company is well capitalised, analyse the business plan and internal operations, and decide if the company has a sustainable business model. Licensed brokers must submit regular, in some cases, daily reports to regulators and undergo regular audits.
Many regulators have strict rules on how brokers execute orders, how products are marketed and sold, have official complaints procedures and operate investor compensation funds.
Although many prominent cryptocurrency exchanges hold some registrations and licenses, the purpose of those authorisations is misleading. These licenses and registrations typically relate to handling fiat, holding funds on an account, and money transfer services. Therefore the exchange marketplace and trading platform they operate is not subject to regulatory oversight.
Most cryptocurrency exchanges supporting margin trading require you to fund your account with crypto to start trading. The exchanges that support fiat payment methods need you to first buy crypto or stablecoins via bank transfer or card payment while charging 3-5% for the transaction.
In contrast, forex and CFD brokers offer numerous payment methods to deposit fiat to your trading account and rarely charge for deposits. Most brokers support credit and debit card transactions, bank transfers and various e-wallets.
Although some brokers accept cryptocurrency deposits, they typically convert them into a fiat balance when crediting to your trading account. As your trading account balance is denominated in fiat, you don’t need to worry about price volatility or exchanging stablecoins to fiat. You can use the same payment method to withdraw your funds.
Since forex and CFD brokers don’t settle transactions in cryptocurrencies, they don’t hold crypto balances; therefore, they aren’t at risk of hacks and theft.
Cryptocurrency exchanges, by and large, have been left to their own devices when it comes to developing platforms. Although some exchanges have done a great job, many lack stability, simplicity, and numerous essential tools and indicators. On the other hand, CFD brokers offer standardised white label trading platforms like MetaTrader 4 and cTrader, supported by hundreds of developers.
Although the points mentioned above are very important, trading in a safe and secure environment comes with tradeoffs.
While some cryptocurrency exchanges list hundreds, even thousands of coins and tokens, many cryptocurrency CFD providers offer a dozen or less. Most CFD brokers stick to the major cryptocurrency pairs, such as Bitcoin, Bitcoin Cash, Ethereum, and Litecoin, quoted against the US dollar.
CFD brokers licensed in Australia, Japan, Singapore and Europe, where firms are required to follow ESMA rules, and other countries are limited to offering 1:2 leverage on cryptocurrency instruments. Offshore regulated brokers typically offer leverage between 1:5 and 1:10, in line with most cryptocurrency exchanges offering margin trading. Scandinavian Capital Markets offers 1:5 cryptocurrency CFD leverage. Some exchanges offer perpetual futures contracts and traditional futures contracts and offer leverage between 1:20 and 1:100 or higher. Using leverage as high as 1:100 on cryptocurrencies is considered reckless.
When trading CFDs, there are three costs to bear in mind; spreads, which some brokers apply a markup on, commissions for opening and closing positions and overnight swaps for positions open at 17:00 EST.
The same fees apply when trading cryptocurrency futures but in different formats. For example, the commissions you pay vary depending on whether you’re a maker or a taker in the transaction. Spreads are still a factor on exchanges. However, spreads are determined by the market. During periods of low liquidity or high volatility, prices can gap immensely as exchanges don’t filter out erroneous prices, whereas a CFD broker would. Instead of daily swap fees, perpetual futures incur a funding rate charged every eight hours.
When trading futures on crypto exchanges, your counterparty is another trader speculating the price will move in the opposite direction. If there isn’t enough demand on the other side, it can take a while to close your position, leading to slippage. Futures market prices can deviate from the spot prices since traders are trading contracts based on what they believe the price will be in the future, rather than what the price is right now.
When trading crypto CFDs, the broker is the counterparty. Brokers either offset your order against other customers or buy crypto from the market to hedge the risk. It’s common for brokers to connect to more than one exchange to ensure better liquidity and pricing since CFD prices originate from the spot market and are closer to the actual market price.
Cryptocurrency CFDs and futures contracts are similar but not like-for-like. Some bold differences between the two instruments significantly impact trading strategies’ efficacy and risk management.
Most, if not all, CFD brokers offer free demo trading accounts to practise your trading. Unfortunately, cryptocurrency exchanges don’t offer demo accounts, meaning you have to risk real money while practising.
Can I trade cryptocurrency CFDs from the United States?
No. If you’re a United States citizen or resident, you cannot trade CFDs. CFDs are prohibited in the US, and overseas brokers should not provide these instruments to US-based traders.
What is the difference between a CFD and a perpetual futures contract?
Perpetual futures, like those traded on BitMex, are similar to CFDs because you can trade with leverage, they don’t expire, and there isn’t any settlement. However, with CFDs, your counterparty is a broker, whereas futures traded on an exchange are traded peer-to-peer and only facilitated by the venue. Another important difference is that CFDs incur a daily overnight fee known as swaps, whereas perpetual futures incur a funding fee every eight hours.