What Can You Do On An Exchange?
A guide to the different functions of a regular crypto exchange
We previously discussed how to get started on a cryptocurrency exchange, today we will expand on that, and discuss some of the key features of exchanges and how you can use these features to your advantage.
As a quick recap, a cryptocurrency exchange is a platform, either on web or in the form of an app, that allows users to trade cryptocurrency for other cryptocurrency or traditional fiat currency. Within that basic premise, there are a lots of other features, some of which we will cover today:
- Order books
- Margin Trading
- Fractional shares
- Fractional NFT trading
- Derivatives (futures and options)
The order book is a feature of a centralised exchange, and is much like the older stock market model. You can place buy or sell orders to fill at a future date (if the price reaches said order price). This is useful for planning out trades, setting stop losses and getting good prices in periods of market weakness. We cover more on the order book in this tutorial.
Margin trading is when you qualify to borrow money against your existing assets to buy more assets. In theory, this could increase your returns, but there are risks involved.
Welcome to the world of leverage! When a trader chooses to trade on margin, they increase their buying power by borrowing from the exchange at a multiple of the assets they have deposited. Say you had $1000 in your exchange account, and leveraged 2x, you would have $2000 purchasing power. This means you could go to the market and buy $2000 worth of assets. You would repay the 'loan' when you sell the asset. What does this do to your returns? Well it doubles them, but it also doubles your potential losses. You pay an interest rate on this loan.
Crypto markets are very volatile, which means that margin traders need to be particularly careful when taking their positions. For this reason, margin trading is not recommended to new traders because it requires advanced risk management strategies.
Fractional shares allow investors to buy part of a share which means that investors can buy small amounts of expensive equities. As an example, imagine there is a company with a share price of $3000. With fractional share trading, you can invest any amount, say as little as $30 and so you would own 1% of a share.
An innovative feature on some exchanges is the fractionalisation of NFTs. This means that users can buy fractions of a whole NFT, for example, a Bored Ape, via a futures contract. And as such, when the NFT is sold, users can receive a share of any profit. This significantly lowers the barrier to entry to purchase valuable NFTs - for example, Bored Apes are priced at around $300,000.
The NFT market outperformed both the crypto and traditional stock market in the last year. The NFT sector is expected to grow between 35 - 54% CAGR over the next 6 years. This makes the fractionalisation of NFTs an extremely attractive proposition for retail investors coming to the platform.
These are leveraged trading instruments offered on some exchanges. They are assets who's price is derived from the underlying asset. A futures contract is a promise to buy an asset at a given date, and an option contract gives the purchaser the option to buy an asset at a certain price at a specified date. These two instruments allow you to increase your purchasing power, and have very different payouts depending on the price change. These instruments can be very useful for hedging, but many traders also use them to speculate.
Futures are a leveraged product and you need to be careful as you can lose more than your initial deposit if you do not manage you risk properly.
The advantage to these instruments is that you can achieve a lot more profit from the same amount of capital when compared to spot trading.
Spot Trading is trading an asset for immediate delivery on an exchange (this involves no leverage).
At Scallop we love exchanges, they are the central hubs that allow the world of cryptocurrency to exist. We believe that there is huge utility in these exchanges and are really excited about the technology. We would encourage you to learn how to use exchanges, and watch this space!