What is Spot Cryptocurrency Trading?

Spot trading is the buying and selling of cryptocurrencies at the current market price, also known as the spot price, with the intention of immediately delivering the sold cryptocurrencies. “Delivery” in this context refers to the fulfillment by the buyer and seller of their obligations under the transaction, while the buyer offers payment, and the seller offers cryptocurrency.

Spot traders usually buy cryptocurrencies at the current market price with their available capital, hold the crypto for a certain period of time in the hope that the price will rise in order to eventually sell the crypto and make a profit. Spot trading is popular with traders as they can take short-term positions with low spreads and no expiration date.

Spot traders can also open short positions in the cryptocurrency spot market. This involves selling the cryptocurrency and buying it back when the price drops.

Ownership of real cryptocurrencies that are bought and sold is different from derivatives trading, such as a cryptocurrency contract for difference (CFD), in which the traded asset only tracks the price of the cryptocurrency and does not transfer ownership of the cryptocurrency to traders.

Learn more about Spot Cryptocurrency Trading

What is a spot price?

The spot price is the current market rate for the immediate purchase or sale of a particular asset.

What are Spot Cryptocurrency Trading Pairs?

Trading pairs describe assets that can be exchanged for each other. There are two main types of trading pairs in the cryptocurrency spot market: cryptocurrency-fiat pairs (eg ETH/USD) and cryptocurrency-cryptocurrency pairs (eg ETH/USDT).

What is an order book?

The order book gives traders information about the depth of a given market. It displays a list of open orders to buy and sell the selected cryptocurrency in real time. There are two sides to the order book:

Buy Side: Shows all open buy orders below the last traded price. Offers from buyers are called “bids”.
Sell Side: Shows all open sell orders above the last traded price. The offered selling price is called the “ask”.

An open order refers to outstanding orders that have not yet been executed.

Different types of orders

On the spot market of cryptocurrencies, you can place various orders.

Limit order

This allows spot traders to prepare spot trades in advance. Users can set the desired price at which they want to buy or sell cryptocurrencies, called the cap price. As soon as the market price reaches this price, the trader's order will be executed, which will be possible due to the conditional agreements that were specified by the trader.

Market order

A market order is executed immediately at the current market prices. This type of order is used by traders when they want to execute their trade order as quickly as possible. Spot traders can place this order easily without having to enter a price. After the execution of a market order, a trader can immediately buy or sell his assets at the best available spot price.

There is no guarantee that the market price will not change during the execution of an order, especially given the volatility of the cryptocurrency market.

Traders can refer to the transaction history to track the type of orders they have placed.

What is a transaction fee?

Most exchanges charge a transaction fee on every spot trading order. The amount of the commission depends on whether the trader is a maker or a taker.

Baker's Commission

Takers are traders who remove liquidity from the order book. The buyer who submits a market order is considered a baker. A trader whose order immediately matches an existing buy or sell offer is subject to a taker fee.

Maker commission

A maker is a trader who provides liquidity to the market by increasing the depth of the order book. A maker fee is charged when a trade order is placed in advance using limit orders.

However, not all limit orders are subject to a maker fee. For example, when a trader is immediately matched with an order, a taker fee may be charged instead. To ensure that the maker fee is charged, traders can place a limit order in such a way that it is not immediately matched with the order, even if the conditions are met.

Differences between spot trading and margin trading

In spot trading, traders buy cryptocurrencies with their existing capital, fully owning the asset after the transaction.

In margin trading, traders borrow capital from a third party to complete the purchase of cryptocurrencies. This allows margin traders to purchase larger amounts of cryptocurrencies or enter larger trading positions, which makes it possible to earn more significant profits. However, this approach is considered riskier because a losing margin trade could potentially amplify losses and cost margin traders more than their initial capital.

In addition, margin traders are required to meet their margin requirements at all times in order to avoid receiving a margin call, which could lead to a sell-off of the trader's assets. As such, margin traders must constantly monitor their trades. In addition, margin borrowing costs can accumulate, causing margin traders to trade more often on shorter time frames than spot trading.

Differences between spot trading and futures trading

In spot trading, cryptocurrencies are bought for immediate delivery, and spot traders become owners of the underlying asset. After that, spot traders usually wait for the price of the cryptocurrency to rise before locking in profits.

Futures traders, on the other hand, do not own the underlying asset; they simply own the contract, which represents the value of the cryptocurrency. In futures trading, the buyer and seller agree to exchange a certain amount of cryptocurrency at a certain price in the future, which is then fixed in the contract until the transaction is completed at a later date. When the contract expires on a predetermined date, the buyer and seller come to a settlement.

The main difference between spot trading and futures trading is the use of leverage. Futures trading allows leverage so that futures traders can enter a larger position even if they have a smaller account balance.

Cryptocurrency Spot Markets

Spot markets, also known as cash markets because traders pay upfront, are available across a wide range of asset classes. These include stocks, bonds and the foreign exchange market (Forex). NASDAQ and NYSE (New York Stock Exchange) are the two most popular spot markets.

To understand how the spot market for cryptocurrency spot trading works, let's take a look at the BTC/USDT spot trading pair.

Buyer A, with 1 USDT, places an order to buy the equivalent amount of BTC at a unit price of $000. Buyer A will be matched with Seller B, who offers BTC in exchange for USDT at Buyer A's desired price. As soon as buyer A and seller B agree on a price, the order will be filled and immediately put on sale.

Spot markets are generally subject to market sentiment, and spot prices for almost all cryptocurrencies fluctuate widely. Therefore, understanding market sentiment is a useful skill for spot traders.

There are different types of spot markets for cryptocurrencies, which we will cover in the next section.

Exchange

Exchanges are platforms that combine market demand and supply, allowing spot traders to quickly buy or sell cryptocurrencies at the market price. There are two distinct exchanges in the cryptocurrency spot markets: centralized exchanges (CEX) and decentralized exchanges (DEX).

Centralized exchange

CEX acts as an intermediary between spot traders and cryptocurrencies, acting as a custodian and managing the cryptocurrencies traded. CEXs provide an order book that provides spot traders with information about the amount of cryptocurrencies available for sale as well as market demand for cryptocurrencies. This is useful for assessing market liquidity available for trading.

CEXs provide spot traders with access to fiat-to-crypto trading pairs. To start spot trading, users just need to deposit fiat or cryptocurrency funds into their account.

There are certain responsibilities specific to CEX:

Ensuring smooth transactions
platform security
Customer protection
Compliance
Fair pricing
Know Your Customer (KYC)
Anti Money Laundering (AML)

Because CEXs offer the above features and services to users, spot trading on CEXs often includes transaction fees. Fees are also charged for listing and other trading activities. Thus, CEXs can make a profit regardless of the state of the market, as long as they have enough trading volumes and users.

Decentralized exchange

This type of exchange is most commonly used for cryptocurrency trading. DEXs have similar features and services to CEXs. However, the main difference is that there are no intermediaries on the DEX. The matching of buyers and sellers takes place using blockchain technology, where smart contracts with pre-set rules are used to make transactions directly from the trader's wallet. With self-executing codes, traders can complete trades without having to trust an intermediary to complete the trade for them. In addition, the traded cryptocurrency does not need to be stored on the CEX, which gives traders full ownership of the cryptocurrency.

When using DEX, traders are not required to create an account and can bypass the KYC process. This gives users much more privacy and freedom, allowing them to trade directly with other people. However, in the event of technical issues, the lack of KYC and customer support leaves the trader in a quandary.

Some DEXs use a book order model similar to the CEX model. A more recent development in this area is the Automatic Market Maker (AMM) model, for example, Uniswap and PancakeSwap. AMMs use a formula to determine prices and use liquidity pools.

OTC trading

Spot trading can be done through OTC trading or P2P trading, each with its own advantages.

OTC trading is considered OTC because the buyer and seller transact directly, without the involvement of a third party or trading platform controlling their trading. The buyer and seller do not use an order book, but can enter into transactions with any cryptocurrency at any price that they both deem appropriate, even if it is below or above the market.

OTC trading is popular among spot traders due to the following benefits:

Slip Reduction

Using the order book can lead to slippage, especially for low liquidity cryptocurrencies such as small cap cryptocurrencies. This results in spot traders not being able to fill their order at the desired price. OTC trading bypasses the order book, allowing spot traders to fill their trading positions without facing a lot of slippage.

Reduced market volatility

Because OTC traders transact outside the market, they can trade in large volumes without worrying about the volatility that might result from trading on the open market.

How to profit from spot trading

Spot trading allows users to hold tokens for several years. As such, many traders use it to average the dollar value (DCA) of their favorite cryptocurrencies. Please note that profits become “real” only when cryptocurrencies are “transferred”, i.e. converted into fiat currency or stablecoins. It is at this point that cryptocurrencies become subject to taxation, but they can be held indefinitely before being taxed.

Benefits of spot trading

Transparent prices

Prices in the spot market are completely transparent and can be seen in the order book. Prices are based solely on market demand and supply. Unlike other trading instruments, such as derivatives (futures, options, etc.), where prices depend on many factors, including time, funding rate, interest rates, and others.

Simple process

Spot traders can easily calculate their risk and reward based on the entry price and the current market price. This is because spot traders own cryptocurrencies directly and therefore do not have to worry about other factors such as maintenance margins and interest payments.

Simple

As mentioned above, spot traders will not be liquidated or receive a margin call, unlike margin trading. In this way, spot traders can “set it and forget it” by marking profits only when they want to take them. On the other hand, given the volatility of cryptocurrencies, derivatives traders using leverage and margin must constantly monitor their positions to protect themselves from liquidation.

Spot traders can also enter and exit a trade at any time without the need to constantly monitor their trading positions.

Relatively low risk

Spot trading carries less risk than derivatives trading. Without the use of margin, spot traders are protected from losing more than their initial investment.

holding force

Since no form of leverage or margin is used in spot trading, spot traders are not required to pay interest or maintain margin. Therefore, if a spot trader is confident in a particular cryptocurrency, he can hold it even if the token has fallen in price a lot.

Disadvantages of spot trading

Limited profit potential

As mentioned earlier, spot trading does not use leverage and margin, but only relies on the amount of capital that the spot trader has. Thus, the positions involved in spot trading are limited and spot traders cannot enter larger positions, such as in futures or margin trading. Thus, the profit potential that a spot trader can make is limited.

Slippage due to lack of market liquidity

Over time, spot market liquidity can dry up. Particularly during bear markets, small altcoins usually lose a significant amount of their liquidity given the reduced trading volume in the market.

When this happens, it is difficult for spot traders to buy or sell their cryptocurrencies at a fair market price due to slippage resulting from insufficient liquidity. They will either have to sell their cryptocurrencies at less than the fair market price, or buy cryptocurrencies at a higher than the fair market price, or hold onto their investments in the hope of getting a better price in the future.

Сonclusion

All in all, using the spot market to trade cryptocurrencies can be a great way to own cryptocurrencies at desired prices. The immediacy that comes with trading the spot market can be invaluable if you want instant profit. By comparison, when trading futures, you have to wait for profits and also deal with the risk of losing your initial margin.