Crypto-to-crypto trading: Beware higher volatility, avail of multiple bases

Why go for crypto-to-crypto trading at all and how does one profit from such trading? The cryptocurrencies that were launched later are technologically smarter than those that came earlier

On April 6, the Reserve Bank of India (RBI) asked banks to sever all ties with cryptocurrency exchanges.

Once the three-month deadline gets over and banks close down the accounts of cryptocurrency exchanges, it will become difficult for Indian investors to buy cryptocurrencies. Many exchanges in India are now offering their clients the option to trade between one cryptocurrency and another, instead of doing so between the rupee and a cryptocurrency. Investors should understand the risks of such trading before venturing into it.

Right now, the rupee is the base currency that investors use to purchase cryptocurrencies. In the new scheme of things, the base currency could be Bitcoin, Ethereum or Ripple. Most exchanges will have only two or three cryptos as base currencies that can be used to buy other cryptos.

People who already own a cryptocurrency like Bitcoin or Ethereum would be able to start trading right away. As for those who don't have cryptos, they will have to adopt the peer-to-peer route. "Once all the banks have implemented the RBI ban, the only way for Indians to get into these exchanges will be through over-the-counter trading. Suppose that you have Rs 100,000 and you want to buy cryptos. You will have to find some other person who holds cryptos and is willing to sell them to you," says Nischal Shetty, founder and CEO, WazirX. The industry expects websites to spring up that offer such peer-to-peer transactions.

But, why go for crypto-to-crypto trading at all and how does one profit from such trading? The cryptocurrencies that were launched later are smarter technologically than those that came earlier. For investors, it makes sense to hold cryptocurrencies that are more innovative and have better prospects, rather than hold just hold Bitcoins.

Another reason for investing in a variety of cryptocurrencies is to diversify one's portfolio. "Just as you want to hold large-, mid- and small-cap stocks, similarly in the crypto world you want to hold some high-value and stable currencies, and others that are of lower value but are more volatile," says Shetty. Moreover, investors have different strategies for different currencies. "They want to hold some currencies for the long-term while they want to use others for trading," says Akash Aggarwal, chief executive officer (CEO), Alluma.

Companies dealing in cryptocurrencies have now begun to issue tokens, which allow investors from all over the world to invest in their projects, rather than only in the cryptocurrency. "The value of these tokens depends on the company's performance, just like in the case of shares. A forthcoming major announcement from a company could send the price of their tokens soaring. Investors want to profit from such events," says a spokesperson at Koinex.

One risk that investors will encounter in crypto to crypto trading is higher volatility. Imagine a situation where an investor is trading between the rupee and a crypto. He enters the market and enjoys a 50 per cent gain. Anticipating a correction, he sells his cryptos and moves into the rupee. His money is now in a currency that is stable. At best, cryptocurrency exchanges in India will have two or three base currencies. In certain situations, all the three base currencies could correct simultaneously. To deal with this situation, cryptocurrency exchanges may in future launch a currency called Tether, whose value is pegged to the US dollar, which will provide the required stability.

When choosing an exchange for crypto-to-crypto trading, check out how many base currencies it has that can be used for trading against other currencies. Aggarwal suggests that you should also make sure that the exchange you are entrusting your money with observes a high level of security protocols.