Disclaimer: This is for informational purposes and is not meant to serve as financial or investing advice.
What Is Spot Trading in Crypto?
Spot trading is when you place market orders for cryptocurrency that execute immediately. Think of spot trades as being performed “on the spot.”
Spot trading is standard in traditional financial markets, such as the stock exchange. Like other prominent trading concepts, such as margin trading, the world of digital assets has adopted spot trading from the long history of speculation on traditional financial assets.
When you spot trade, you are holding or selling the cryptocurrency one-to-one. There is no leverage or agreement to buy or sell in the future. Other types of trades, like limit orders, will be executed in the future.
How Does Crypto Spot Trading Work?
To execute a spot trade, you must open an account with a centralized exchange (CEX) like Coinbase or Binance. Then transfer USD (or other fiat currency) to your crypto exchange account.
You can deposit by connecting your bank account, using debit/credit cards, or sending external cryptocurrency to your exchange account.
Once a spot trader loads up their account with USD, they can buy and sell a crypto asset like Bitcoin using a USD pair like BTC/USD.
Spot orders have immediate delivery. The exchange matches your buy order with a seller looking to sell the same cryptocurrency and swaps in real time.
Of course, the goal with spot trading is to buy undervalued assets and then sell them later. Spot traders perform technical analyses by reading price charts.
What Are the Benefits of Spot Trading Crypto?
1. It’s a Simple Option
If you believe a crypto’s price will increase, you buy it and open a “long position.” If you believe the price will decrease, you can market-sell your tokens.
There’s not a lot to mess up regarding spot trading. Spot trades are the most basic type of trade. There aren’t limit prices, stop losses, or any leverage to track or plan.
Your position can’t be liquidated in a spot trade. Spot trading with predetermined levels is a way to preserve your capital, i.e., deciding to cut your losses after a 5% drawdown and take profits after a 10% gain.
2. Good for Short and Long-Term Investing
Spot trading takes less planning than derivatives, options trading, or limit orders. So they’re great for reactive, event-driven short-term trades.
Spot trading can be excellent for DCAing into a long-term trade position. Check out our guide to crypto portfolio allocation strategies to learn more.
Another reason spot trading can be excellent for long-term investing is you don’t have to worry about expiry dates or limit prices. You can simply buy and hold tokens and take out profits when your price target is reached.
3. Provides Exposure to Underlying Assets
You are exposed to those assets when you take a long position using spot trades. This is in contrast to derivative or options trading, where you’re trading contracts that grant the rights to buy assets.
There’s a saying in crypto, “not your keys, not your coins,” meaning that they are at risk if you don’t have ownership over your tokens. In crypto, this means taking custody of the tokens in your wallet.
After you buy tokens with a spot trade, you can take self-custody of them in your crypto wallet until it’s time to sell them. You can’t do this with derivatives or futures trading.
When it comes to security, this can be a drawback. If you are trading on an exchange that isn’t reputable, it might be better to spot trade and withdraw the tokens. If you trade with leverage, you are betting on that token’s future price, and the exchange’s honoring your leverage trade sometime in the future.
4. Take Advantage of Emerging Market Opportunities
Emerging markets are a great place to spot trade. Most of the time, spot trading is the only option with new crypto tokens.
When exchanges offer a new token for the first time, this could be an excellent opportunity to spot trade. Early investors may rush to sell their tokens on the exchange now that there’s liquidity.
So it’s always wise to research a token listing before trading it. But there are always opportunities to make profitable spot trades in emerging markets.
One way is by finding and capitalizing on differences in spot prices across exchanges. You can learn more about this strategy in our guide to arbitrage.
What Are the Risks of Spot Trading Crypto?
1. Volatility of Crypto Markets
Volatility refers to fluctuations in the price of an asset. The more volatile a token is, the more the price changes within a given timeframe.
Because volatile crypto markets swing in both directions, spot trading can be a drawback because you can’t open a short position in the spot market. You can only buy and sell tokens.
Crypto, in general, is more volatile than traditional equities or even forex markets. The spot market can be challenging to gain an edge in reliably.
2. Lack of Leverage
Spot trading doesn’t have any leverage. If the price increases by 10%, your profit increases by 10%.
Because there’s no leverage, you may think you’re missing out on extra profits when a token’s price increases. With 2x leverage, that 10% profit could have been 20%.
But, a reason to spot trade is to reduce risk. When you use leverage, you should monitor your position, or your collateral closely could be liquidated. When you spot trade, you can “set and forget” the trade without babysitting stops and take profit levels.
For more information about leverage trading in crypto, read our guide to leveraged ETFs.
3. Various Fees
There are trading fees on most exchanges for spot trading. If you’re spot trading on a decentralized exchange (DEX), there will be smart contract fees for using the trading platform. And there will likely be transaction fees for the underlying blockchain.
On top of fees, if you make lots of spot trades like a day trader, you could incur unnecessary tax burdens. Taxes should be considered in your trading strategy like any other fee.
Because of taxes, in some scenarios, it might make sense to leave long positions open instead of repeatedly closing positions and trying to buy the dip.
It’s essential to plan for fees when you make your trading strategy. To save on expenses, check out Pluto’s automated trading strategies for free here.
Crypto Spot Trading FAQs
Is Spot Trading a Good Option for Crypto Beginners?
Spot trading is beginner friendly because it’s the type of trading where the least amount of things can go wrong. You need a centralized exchange account and a thesis on which tokens to go long.
Many experienced traders would tell a beginner never to touch leverage. Even veteran traders must improve with leverage and lose all of their capital. It cannot be overstated how lack of liquidations and other built-in risks is a massive benefit for spot traders.
What Is the Difference Between Spot Trading and Futures Trading?
Spot trading and futures trading are two different ways to trade crypto. As mentioned before, with spot trading, you buy and sell the actual cryptocurrency at market price, and the transaction executes immediately.
In futures trading, you buy and sell contracts that give the holder the right to buy the underlying cryptocurrency. For example, you may purchase a futures contract that gives you the right to buy Ethereum at $1500 in 2 months.
As you get closer to that expiration date, the value of the contract will go up or down based on how close the market price is to the predetermined price at which you agreed to buy ETH. This price is also called the strike price.
As you can tell, futures trading is much more complex than spot trading. You need a detailed understanding of futures contracts and the mechanics of the underlying market.
If you make a mistake, you could hold worthless futures contracts — a 100% loss on your invested capital. With spot trading, it’s much less likely that your investment will quickly go to zero.
The Bottom Line
Spot trading is like any other financial instrument in that it’s a tool you use in specific situations. Spot trading is excellent for beginners that want to self-custody tokens.
Spot trading is also great if you want exposure to an asset without worrying about complicated futures pricing or leverage rules. You don’t have to babysit open positions because they can’t be liquidated.
Ready to try your hand at spot trading crypto assets? Practice your trading strategy with Pluto’s paper trading tools, and set up your personalized trading strategy today.
Sources:
Cryptocurrency Futures Defined and How They Work on Exchanges
