Trading Cryptocurrencies - Direct Trade vs. CFD

Cryptocurrencies have received a lot of attention in recent years, especially since the beginning of 2021. During this time, Bitcoin was able to almost double in value. Altcoins such as Ethereum, Cardano or the Binance Coin were able to record even stronger increases. Therefore, many investors and traders are very interested in getting into trading with digital currencies. In the following article, we shed light on the difference between trading cryptocurrencies directly as well as CFD trading with them. We also discuss when buying directly and when trading with a CFD makes more sense.

What is the difference between direct trading of cryptos and CFD trading?

The biggest difference between direct Bitcoin trading and CFD trading is that in the former method you acquire the cryptos directly, whereas when you acquire a CFD you do not invest directly in Bitcoin and Co.

When buying real cryptocurrencies, you have to acquire them via one of the many crypto exchanges. Thanks to the blockchain technology behind the digital currencies, which in simple terms works like a kind of notebook, the corresponding purchase is recorded in the blockchain in encrypted form. After the purchase, one owns a certain amount of the acquired digital currency, depending on the amount invested.

However, you should never park your digital assets on the stock exchange. It is highly recommended to transfer them to a wallet, preferably a hard wallet that is separate from the World Wide Web. Here, the coins are stored in a kind of safe wallet.

Buying a CFD, on the other hand, gives you the opportunity to participate in cryptos' price increases or decreases without investing directly in them. To explain: A CFD (abbreviation for contract for difference) is a derivative financial instrument that exists for various underlyings. In addition to shares, commodities or similar, you can now also agree on a CFD on bitcoin and the whole range of altcoins.

CFD trading works in such a way that you enter into a contract with your broker on the price of a certain cryptocurrency, which serves as the underlying asset. You can decide whether you believe in rising or rather falling prices. If you are right, your broker will owe you the difference between the price at the time of closing and the price when you sell the CFD. To maximize profits, you can also work with different levers, but they are strictly regulated in the EU.

When does direct trading and a hard wallet make sense?

Direct investing in cryptocurrencies is most suitable for those who want to participate in the performance of their digital assets in the long term. If you don't mind the short-term high volatility and believe that cryptocurrencies will have a multiple of their current value in the future, you should prefer direct trading. Also, if you like to own various altcoins and want to build a diversified crypto portfolio, trading through an exchange would be preferable.

Furthermore, there are various other ways to generate passive income with digital currencies nowadays, e.g. via staking, lending or mining. However, there are some tax pitfalls here. In the case of staking, lending and the like, the tax treatment has not yet been conclusively clarified. At the moment, however, it can be assumed that the resulting earnings could be taxed in the same way as trading. But that will become clear in the future.

Another disadvantage of direct trading is the secure storage of one's assets. As already mentioned, a hard wallet is suitable for this purpose. However, the purchase of such a wallet incurs additional costs in the triple-digit range. Therefore, the purchase is only worthwhile if you hold a larger sum of cryptocurrencies. On the other hand, you have to remember a longer passphrase in case you lose the wallet or store it in a safe place to get your coins back. Things can also go wrong when transferring cryptocurrencies to the wallet if there are no security precautions in place. And last but not least, not every altcoin is compatible with every wallet.

When does trading CFDs on cryptocurrencies make sense?

If you want to speculate on short-term fluctuations in prices, CFD trading is much more suitable. Unlike direct purchase, which speculates on long-term rising prices, you can also speculate on falling prices when purchasing crypto CFDs. So, more options are open to you. Since you are not purchasing real cryptocurrencies, you do not have to worry about their safekeeping. There are no additional costs for buying a hard wallet.

From a tax point of view, CFD trading with Bitcoin and other cryptocurrencies is like trading with other underlying assets. Accordingly, losses and profits are offset against those from other CFDs and the profit is taxed at the end.

The option to trade a CFD with leverage increases the potential profit opportunities, but at the same time, of course, also the amount of possible losses. In any case, the short-term return from the price fluctuations can be significantly higher than that of a direct investment in Bitcoin and Co. In the EU, strict regulation limits the leverage when trading CFDs on cryptocurrencies to a factor of 1:2.

An interesting option is offered if physical cryptos are already in the portfolio. By using a CFD on falling prices, you can hedge your investments in the short term in order to minimize losses in case of price declines. Thus, a CFD and physical investments are not generally mutually exclusive. Rather, they even complement each other.

Conclusion: real cryptocurrencies or CFDs after all?

A blanket judgment about whether direct trading or CFD trading with cryptocurrencies is better cannot be made. Both methods have their advantages and disadvantages. You should balance these with your individual preferences and investment goals. In short, the conclusion is as follows: If you want to invest in cryptos for the long term, you should prefer direct buying. On the other hand, if you want to speculate in the short term, crypto CFDs are the better choice.

The physical purchase is more suitable if you:

• want to speculate on rising share prices in the long term,
• you would like to acquire a broadly diversified portfolio of different Altcoins and
• you want to benefit from the further development of smart contracts.

You should prefer trading with a CFD if you:

• wish to profit from short-term price fluctuations,
• you like to work with levers and are risk-affine and
• They do not want to have any hassle regarding the storage of their cryptocurrencies.

As already mentioned, depending on your own investment strategy, a combination of CFD and direct purchase of real Bitcoins can also make sense. No matter which approach you favor, you should always choose a reputable broker or crypto exchange for trading.