What is a cryptocurrency CFD, and how does it work?

Cryptocurrency CFDs, or crypto CFDs, allow you to make a profit by speculating on the price of certain cryptocurrencies without spending a lot of your money to actually buy those cryptocurrencies. 

Cryptocurrency CFDs are traded in pairs, like BTC / USD, ETH / BTC, LTC / USDT, and so on. When you trade in CFDs, you bid on how the first currency will move against the second. 

You can speculate on a price increase, which is called ‘going lon’, or speculate on a decrease in price, which is called ‘going short’. If the price changes in the direction you speculated, you earn a profit. You register a loss if the price moves in the opposite direction. 

As CFDs are leveraged, you only need to put up a small percentage of the trade amount to open a position. Leverage refers to using borrowed money to trade or invest in an asset. When you purchase a CFD, you are only required to put up a small percentage of the trade amount (known as the margin), and the rest is loaned by the provider. However, your profit or loss is calculated on the full trade and not your margin amount. In this way, leveraged products like CFDs can magnify your profit as well as your loss.

Cryptocurrency CFD trading allows you to speculate on the price movement of a cryptocurrency by investing a small amount of your capital. The amount you pay for a CFD is called the ‘margin’, which is a percentage of the actual price of the cryptocurrency you’re buying. Here’s an example to help you understand this better. 

Assume the price of Bitcoin is $100. If you engage in traditional trading, you must spend $1,000 to buy 10 Bitcoin. These coins would then be your property, and you could do what you want with them. 

CFDs work differently. A CFD is not an actual coin but a contract you open with the exchange platform. The exchange will list a Bitcoin CFD pair (assume it is BTC/USD) at a margin, which is a percentage of the actual price of a single Bitcoin. For this example, let's assume the margin requirement to be 20 per cent, which means you need to pay 20 per cent of the actual price of a single Bitcoin to open a single BTC/USD contract. Accordingly, you’ll need to pay $200 to purchase 10 BTC/USD CFDs, which is 20 per cent of $1,000, the actual price of 10 Bitcoin. 

Here’s how these two trades (buying Bitcoins vs buying BTC/USD CFDs) would look like:  

When you buy CFDs, you also need to take a long or short position, which means you need to bid whether the price of the underlying asset will increase or decrease, respectively.  And, if the price moves in the direction you predicted, you can receive 100 per cent of the gains, even though you only invested a percentage of the total price of the trade.

In this example, if the price of Bitcoin were to increase by $10, you could earn a profit of $100 had you speculated a price rise. You’d have earned the same amount of money had you purchased 10 Bitcoin instead of buying Bitcoin CFDs. This is illustrated in the table below:

Even though the profit is the same in both scenarios (as you can see in the table), your initial investment is lesser when you purchase CFDs instead of buying the underlying asset.  In this way, CFDs magnify your returns by allowing you to trade on the margin. However, margin trading also magnifies your losses as they are calculated on the full value of the trade (instead of the margin percentage). 

In the same example, if the price of Bitcoin were to reduce by $10, you’ll incur a loss of $100. However, the loss incurred in traditional trading is 10 per cent of the initial investment, whereas the loss incurred in CFD trading is 50 per cent of the initial investment. The risk involved in CFDs, therefore, is much higher.

What’s interesting is that in CFD trading you can also bid on the price of the underlying asset dropping and make a profit.

CFDs are high-risk-high-reward trades. Since the initial investment needed to purchase CFDs is lower than the investment needed to purchase the underlying cryptocurrency, it’s easier and cheaper to get started with CFDs. For the same amount, you can purchase more CFDs than the actual cryptocurrency, which means you can make a larger profit, but your risk of loss is also amplified. 

If the market moves against your speculation, you’ll be exposed to higher risk when investing in CFDs. When you engage in traditional trading and buy a cryptocurrency, the maximum loss you could incur is the total amount invested (if the crypto falls to $0). With CFDs, however, the loss can be more than the amount you invest. For example, if you invest $1000 and buy 10 CFDs and the price of the underlying crypto drops by more than $100, you could lose more than you invested. 

Although CFDs allow you to invest in the crypto market without using much of your capital, there’s a high chance of losing money when you trade CFDs. Therefore, it’s important to understand how CFDs work and the underlying risks of margin trading before investing your hard-earned money in a volatile market. 

If you are buying cryptocurrency CFDs, you should also consider studying the underlying cryptocurrency and closely follow its market position to try and profit from its price movement. But remember, you are only making an educated guess at best, and there’s no guarantee that your investment will bring you returns. You could also speak to a financial expert if you need advice on building a well-diversified investment portfolio.