There are a variety of ways in which you can trade crypto today. Of course, the most popular options are through an exchange or peer-to-peer trading.
But two other trading options that are gaining traction in the crypto world are Contracts for difference (CFD) and Exchange Traded Funds (ETF).
In today’s article, we will be exploring how a crypto CFD and a crypto ETF are different from one another.
What is a CFD?
CFD, which is abbreviated from Contracts for Difference, is a trading instrument which tracks the price movement of the underlying asset.
A contract buyer predicts the price of a crypto, and if he sells the contracts before an anticipated price slump and if his predictions come true then, he still makes profits even if the crypto crashed.
But if the crypto’s price turns out to be the opposite of the predictions then the contract owner suffers losses.
What is an ETF?
An ETF, abbreviated from Exchange Traded Fund, is an investment fund which is traded on stock exchanges, just like a common stock. The crypto ETF holds the asset and through an arbitrage mechanism, the value of the contract is kept close to the crypto’s net value.
This type of fund involves the ownership of underlying assets which can be anything from bonds, stocks, oil futures, gold bars, fiat and crypto currency, and the assets are divided into shares and sold to investors.
Crypto CFDs vs Crypto ETFs
A crypto CFD is a high-risk leveraged contract because you typically use increased trade leverage. This means that you borrow a large amount for the trade which not only increases your gains but your losses as well, making the trade very risky.
An ETF is a fund that just tracks an underlying crypto asset, no leverage trading, no liquidation deadlines, which makes it a low-risk trading option.
A CFD buyer does not own the underlying crypto. An ETF shareholder does own the crypto asset but not directly. The profits are shared as dividends or earned interest from ETFs.
ETFs are investments that are considered to be less costly than CFDs, as the shareowner only has to pay a small management fee on a yearly basis. ETFs also have no ongoing interest fees.
CFDs on the other hand, require that you invest in the margin total, but if you want to extend the deadline which is usually really short, it becomes very costly to keep a CFD active for long. In contrast, with CFDs, you gain access to a product that tracks the price of the underlying asset.
This is why CFDs are more ideal for short term profits, while ETFs are better as long term investments.
CFD allows you to buy or sell at an initial price for a tracked crypto, then later close the contract with an opposite buy or sell in the same underlying crypto. The deadlines for these contracts are short, and prolonging their term is expensive. As such, CFDs are an investment method that goes best with a short term strategy.
ETFs are better to gain a passive investment, usually in a long-term holding strategy. ETFs can be traded on the stock market similar to how you trade company shares that are listed.
A CFD broker account allows you to trade in a wider range of different markets all over the world. CFDs owners have the advantage of short-selling an asset group or market as well as the ability to hedge the underlying crypto. ETFs, on the other hand, are more limited to being an investment tool in which funds are mainly held.
The most interesting difference between the two investment vehicles is that a crypto CFD can be used to hedge exposure in ETFs, but the opposite is not possible. A disadvantage for ETFs is shareholders are able to get exposure to specific sectors or the entire share market, but in general, there is no elite selection in the underlying crypto portfolio of the ETF.
When a particular sector is gaining popularity, it can lead to an increase in the share price for that particular sector. If the fund contains the indexes from that particular sector, an ETF will be forced to buy more shares from those companies or crypto assets in order to drive the prices further. Thus ETFs can be used to influence the value of crypto businesses and digital assets that are in relation to them.
The buying or selling of a CFD does not influence the crypto market or related businesses in any way shape or form. This is because the owner of the contract does not hold or transact with the actual crypto, and thus there is no impact on the market supply even if he makes a billion-dollar contract.
A crypto CFD is usually used more for market speculation, while a crypto ETF is more appropriate for a buy-and-hold type of investment. This is because CFDs are leveraged products which are traded on the intra-day basis.
CFDs are derivatives that enable you to profit from a price change, resulting in much higher value than you could afford to buy. But leveraging is very costly when your crypto CFD prediction turns out wrong, and you could stand to lose many times more than you could actually afford.
Between ETFs and indices, there is usually an inverse correlation. ETFs that perform contrariwise to indices will gain value (go up) when the index decreases in value (goes down).
ETFs can also be used in a way that can multiply the difference, as a crypto ETF can increase in price double than the number an index can reach.
Depending on how risk-averse you are, a crypto CFD and a crypto ETF are good investment tools that will allow you to gain exposure to digital assets without having to directly interact with them. Profits can be made using both of them, but you would need to have some insight into the world of trading and crypto before getting involved in any of them.
Featured Image: Bookmap