What are the risks of trading cryptocurrency CFDs?

Crypto has emerged as an alternative investment class in recent years, with many individuals interested in making money by trading cryptocurrency. However, crypto markets are highly volatile, which means that while there is potential for financial gain on the one hand, traders are also vulnerable to loss.

In this article, we will explore five risks of trading crypto CFDs and how traders can effectively manage these risks when trading cryptocurrencies CFDs.

One of the most significant risks of trading crypto CFDs is the volatility of the market. Cryptocurrency prices can fluctuate significantly in a short period of time.

During the three-year period from January 2019 to December 2021, there were 9 days when the total value of the crypto market dropped 20% or more in one day. In fact, the largest losses in crypto occur when risk aversion hits the market.

For example, as the COVID pandemic was sweeping across the globe, the total value of spot crypto fell 43% on March 12, 2020, as restrictions were put into place and many economies shut down.

However, volatility works both ways. Shortly after the COVID restrictions were put into place, crypto began to trend higher by over 1600% for the next 14 months. There were 7 days during that trend where the value of crypto rallied 10% or more in a single day.

One way to manage volatility is to carefully consider your risk levels on the trade. Traders can continue to use a stop loss; however, the higher volatility in crypto price action should be taken into consideration when deciding on a stop level. Additionally, traders may want to reduce their exposure to minimise the overall risk of the trade.

Liquidity is a lesser-known but stealth risk of crypto trading.

Liquidity is the ability for you to enter and exit your trades without moving the market’s price. You may identify a cryptocurrency CFD to trade, but if there aren’t a lot of sellers to match up with your buying size, then the market price has to move higher to attract more sellers.

On the flip side, if you have a large position you are trying to exit, there needs to be enough liquidity to fill your position; otherwise, the price of the cryptocurrency CFD has to fall.

Liquidity in a market ebbs and flows based on the time of day, day of the week, size of the trade, and the exchange or broker you are trading with.

Liquidity is generally higher for bigger and more popular cryptocurrencies like Bitcoin or Ether. As a result, it is easier to open and close large trades on large-cap crypto CFDs.

On the other hand, smaller-capitalisation cryptos and altcoins will have smaller pools of liquidity to draw from. These smaller pools mean the prices may skip around more violently when large orders enter the market.

A popular way to manage potential liquidity constraints is to break up large trades into multiple traders of smaller sizes. Rather than sending 1 large size into the market, you’ll divide the total trade size into two or three smaller sizes. Then, place each of those smaller trades separately into the market, spaced a few minutes apart. This gives the market time to digest the larger volume of trading.

The cryptocurrency market is largely unregulated. This means there may be no government or authority you can turn to after being a victim of cybercrime. For instance, if an underlying cryptocurrency project is exposed as a fraudulent enterprise and abruptly ceases operations, the market value of that underlying cryptocurrency could fall to zero.

Or, hackers may try to steal cryptocurrency from digital wallets or even the exchanges where the underlying digital assets are held.

Even crypto exchanges can be subject to fraud.

In November 2022, FTX was one of the largest crypto exchanges, worth billions of dollars. When information was leaked about the potential mismanagement of FTX client funds, a run on FTX began as traders withdrew funds. Within a matter of hours, FTX filed for bankruptcy, and millions of clients were stuck and lost money as they were unable to receive their account capital back.

Traders should take steps to protect their hard-earned capital. If a project promises endless profits and sounds too good to be true, then it could be a scam. Also, research the crypto trading platform and institutions where you are opening accounts. Are they regulated, and what are other clients saying about their experience using them?

Laws and regulations are also subject to change quickly within the crypto market. Since digital assets and cryptocurrencies are a relatively new industry, there may be limited regulatory infrastructure in place to determine who will regulate crypto assets or what that regulation might look like.

Governments in various jurisdictions may decide to regulate crypto in different ways. As a result, future regulation could be pivotal to the value of a crypto asset, potentially driving traders to sell and causing the value of the cryptocurrency to fall.

As an example, China has cracked down to ban crypto transactions and mining for its citizens. Chinese officials have publicly noted several reasons for the ban, including consumer protection, capital flights, Yuan devaluation and environmental concerns.

On the other hand, there are countries like El Salvador that have embraced Bitcoin as a means of payment for government or private services.

Lack of regulation might sound ideal for crypto CFD traders, but without regulation, scams and frauds are more prevalent. On the other hand, prudent regulation in developed markets would provide a framework for institutional money to trade cryptocurrency CFDs.

That institutional money could be the future demand that drives some cryptocurrency prices higher. Regulated crypto trading platforms will have a higher bar to jump over, providing an extra level of security for your funds.

To trade crypto CFDs securely, traders should use a reputable trading platform that prioritises security, liquidity, and safe custody.

Additionally, trading in crypto products that are more liquid will allow you to enter and exit your trades at fair prices.

Interested in buying and selling popular cryptocurrency CFDs? At OANDA, we know how important trust is when trading crypto CFDs. If you feel ready to trade, make a smarter decision: trade crypto CFDs with the user-friendly OANDA app.