Shane Neagle, Editor In Chief at The Tokenist, talks us through the difference between Bitcoin CFDs and Bitcoin binary options.

There are countless horror stories of people losing access to funds or accidentally locking themselves out of their wallets and losing their hard-earned gains. However, thanks to Bitcoin’s volatile price action, there can be an abundance of trading opportunities for traders who know what they’re doing.

This is where financial contracts can bring added forms of value. With CFDs (contracts for difference) or binary options contracts, investors can strategically use one of these instruments to trade Bitcoin’s price movements — without having to worry about paying transaction (miner) fees, keeping hold of private keys or worrying about Bitcoin restrictions in their country. For this sort of trading, there are two options we’re going to look at here: CFDs and binary options for trading Bitcoin. Both have their pros and cons and the decision of which one to choose will be based on a specific trader’s own objectives, as well as personal preference and risk tolerance. Let’s take a closer look.

What Are Bitcoin CFDs?

A Bitcoin CFD (contract for difference) enables buyers (clients) to take advantage of an underlying asset's price movement by selling to the seller (CFD brokers). By using CFDs, traders do not actually own the underlying Bitcoin and can use fiat currency to place their trades. This often works out cheaper for traders as it means not having to worry about Bitcoin network fees for buying and selling their BTC, as well as allowing for more effective HFT (high-frequency trading) as there is no need to wait for Bitcoin transaction confirmations on the blockchain. Investors can use Bitcoin CFDs to speculate on whether they think the price of BTC will rise or fall - allowing for both long and short trades to be placed. 

Advantages

  • Access to risk management tools, such as stop losses and take profit tools.
  • No expiry date. This means traders can choose how high they want to ride an order with price heading in their direction or conversely if they’re willing to try and ride a trade out that goes against them with the hope that price reverses.
  • No Bitcoin fees to pay for miners or transaction costs.
  • Access to leverage for those willing to take on greater risk for potentially greater returns.

Disadvantages

  • Regulation is thin on the ground for CFDs. This can mean there are fewer standards for brokers to have to meet, which can mean poorly designed interfaces or instances of “overloading” where orders cannot be executed at the desired price.
  • You don’t own the underlying asset. This means traders are reliant on a centralized entity in their broker of choice. The advantage of owning your own Bitcoin is that you are participating in a decentralized network, so there is no single point of failure in case of hacks or attacks on a CFD broker.
  • Banned in the US.

What Are Bitcoin Binary Options?

A binary option is an artificial instrument where the payout is either a fixed amount of a predetermined revenue, or nothing at all. Binary options, as can be implied from the name "binary," deliver an outcome dependent on a "yes or no" proposition. Traders predict if the price of BTC will rise or fall by the time a specific timeframe is reached. The trader receives a payout if the Bitcoin binary options contract expires as predicted (referred to as ‘in the money’), and would lose all of their capital if it goes the other way (referred to as ‘out of the money’).

Binary options are best used for more “sure bets”. An example could be predicting that Bitcoin will rise in price after a halving event, whereby the miner block rewards are halved. These events happen every four years and are typically followed by a rise in price after an initial crash. A trader would not need to know what price level would hit, unlike a CFD, only if the price will be higher or lower than the specified strike price at a date in the future. Many top binary options brokers now accept deposits via Bitcoin, reflecting a trend in the growth of Bitcoin’s popularity and its increasing legitimacy as an asset class.

Advantages

  • Not required to make approximate predictions, rather only if Bitcoin’s price will be above or below a certain level.
  • Fixed payout or loss, making it easier to calculate risk.
  • No Bitcoin fees to pay towards miners or transaction costs.

Disadvantages

  • No risk management tools can be used, such as stop losses or take profit tools. Trade can only be completed when the contract expires.
  • Contract expiry means traders can lose out on profits by only a fractional difference in price - if the expiration hits, the trade is complete, no matter what.
  • Only available on a certain number of regulated platforms in the US.

Advantages Of Bitcoin Derivative Trading

One of the most important things to get right when holding Bitcoin is storing it safely. For investors who prefer to skip these preliminary procedures, trading derivatives is a solution. By using Bitcoin CFDs and binary options contracts, traders can gain exposure to Bitcoin prices without having to adhere to the security measures associated with it.

Other advantages of these instruments include ease of execution and low trading fees — in many cases fees tend to be below 1%. On the contrary, some crypto exchanges can charge high fees—up to 5%—for Bitcoin purchases and trades, particularly when online credit card payments are used. 

Disadvantages Of Bitcoin Derivative Trading

Trading derivatives rather than the actual asset is a double-edged sword. While there won't be safety aspects to worry about, traders do not own the underlying asset. For Bitcoin, owning private keys is considered the ultimate point of the enterprise among many of its investors. As Bitcoin's whitepaper outlines, the leading cryptocurrency was created to remove the need for intermediaries. In other words, if one does not have self custody of their Bitcoin holdings, then it can be said that they don't really “own them”. 

Last but not least, there are also weak industry regulations and liquidity risks associated with CFDs and binary options. It is worth noting that trading CFDs is illegal in the US, and binary options are only available on certain exchanges.

Bitcoin CFDs vs. Binary Options: Which Is Better?

Bitcoin CFDs and binary options both have slightly different use cases. Bitcoin CFDs are best used when a trader is confident Bitcoin’s price will hit a certain level. For instance, if Bitcoin is valued at $40,000 and a trader predicts the price will rise, they can open a long CFD position. It is worth noting that CFDs have no expiry date. A trader can hold their position for as long as they are willing to pay the "premium" (the charge on holding an active position overnight). However, CFD positions can get very expensive after being open for six weeks since they attract levy financing charges. 

Suppose BTC price reaches $42,000 after two days. If the trader decided to close their position, the net profit would be calculated on the $2,000 price difference. How much profit is made will depend on how much money was staked in the trade, as well as subtracting any costs (commission, spread, and the premium for two nights).

Bitcoin binary options are best used when a trader is confident about the direction of Bitcoin’s price but is not sure to what extent the price will be higher or lower than the selected threshold at the time of expiry. This means that, unlike CFDs, these contracts have an expiry date that will trigger at a predetermined time and date.

At the point of expiry, if the prediction is right, profit can be taken. However, if it's wrong, the trader loses all their invested money in the trade. When compared to CFDs, binary options carry a larger risk due to their lack of risk management tools, but have much smaller trading fees and hold the potential for larger profits. 

In Summary

One way to get exposure to Bitcoin price moves is by trading derivatives like CFDs and binary options. Each of these financial instruments come with their own advantages and disadvantages, and traders need to choose the one that best fits their needs. It is worth bearing in mind that trading is highly risky. A large portion of retail investors—involving both CFDs and binary options—lose money. Therefore, never trade funds you cannot afford to lose and always do your own research before investing your capital.