TL;DR
In real-time, “spot trading” involves buying and selling currencies, stocks, bonds, and other financial instruments. If the asset is available quickly. Exchange-based or OTC, spot markets are where traders trade. Spot markets do not allow margin trading or borrowing cash; therefore, traders can only use their own assets.
Spot trading on centralized exchanges optimizes regulatory compliance, security, custody, and more. In exchange, the market takes a transaction cut. However, blockchain smart contracts power decentralized exchanges with the same capabilities.
Introduction
Spot trading is a basic method of investing and trading. Your first steps into the world of crypto investment will almost certainly include a spot transaction on the spot market, such as acquiring BNB at the current market price and holding it (HODLing).
Spot markets exist for cryptocurrency, stock markets, commodities, foreign exchange, and even bonds. You probably know more about spot markets and trading than you realize. Some of the most well-known exchanges, such as the NASDAQ and the NYSE (New York Stock Exchange), are spot markets.
What Is a Spot Market?
Spot markets are public financial exchanges where transactions can occur in real-time. For an asset, a buyer pays a seller in fiat currency or another medium of trade. Delivery may be immediate, depending on the asset traded.
Because transactions occur in real-time, traders commonly refer to spot markets as cash markets. Spot markets can take many different forms, but in most cases, an exchange—an unbiased third party—handles the transactions. Over-the-counter (OTC) trading allows you to interact with other people directly. We’ll get to them soon.
What Is Spot Trading?
Spot traders depend on an asset’s price growing by purchasing and selling it quickly. If the value of their assets rises, they can benefit by selling them on the spot market. Spot traders can also sell short. This technique is based on selling financial assets and then repurchasing them at a cheaper price.
The spot price of an asset is the asset’s current market value. On a stock exchange, a market order allows you to purchase or sell at the best available price at the time. Your order will be executed as soon as possible, but we cannot guarantee that the market price will not change. It is also possible that there is not enough volume to meet your demand at the price you choose to pay. If you want to buy 10 ETH at the spot price but only have three available, you’ll have to find another way to get the remaining seven ETH.
The spot price is dynamic, changing as orders are filled. Spot trading occurs between two parties over the counter. You may discuss a predetermined price and amount with another party without using an order book.
Depending on the item, the delivery timeline ranges from instant to T+2 days. T+2 refers to two business days following the trading date. Until recently, stock and share exchanges required the physical delivery of certificates. Previously, the foreign exchange market operated as a conduit for monetary transfers via wire or deposit. Shipping times have been reduced to nearly nothing as a result of digitization. However, cryptocurrency exchanges are open 24 hours a day, seven days a week, allowing for near-instant trade. However, P2P or OTC transactions may take longer to complete.
Differences Between Exchanges and Over-The-Counter
The spot market is not limited to a single area. Spot trading takes place on exchanges, but it is also practical to trade directly between individuals. These transactions are known as “over-the-counter trades,” as previously discussed. Each spot market has its own variations.
Centralized Exchange
You have the option of using a centralized or decentralized exchange. A single centralized exchange handles currency, stock, and commodity transactions. The exchange not only acts as a middleman between buyers and sellers but also as a custodian for the assets being moved. When you use a centralized exchange, you must deposit the cash or cryptocurrency you want to trade into your account.
To be considered seriously, a centralized exchange must ensure that trades can be completed quickly and easily. Furthermore, you must verify that your company follows all applicable laws and regulations, employs KYC (Know Your Customer), charges clients fairly, and maintains their information secure. In exchange, the exchange receives fees for trades, advertisements, and other types of trading activity. Exchanges can profit in either a bull or bear market as long as they have enough users and transaction volume.
Decentralised Exchange
It’s also common to see cryptocurrencies exchanged on a decentralized exchange (DEX). A DEX can execute some of the most basic duties of a centralized exchange. DEXs, on the other hand, match buy and sell orders using blockchain technology. Users of a DEX can often transact with one another without first opening an account or depositing funds into the DEX.
Smart contracts allow traders to do trades directly from their wallets. Transactions are self-contained chunks of code that are kept on a blockchain. Many individuals like DEXs because they provide their users with greater privacy and flexibility than traditional exchanges. However, there is a cost to this. For example, if you encounter any problems, a lack of know-your-customer (KYC) and customer help can be a source of concern.
Binance DEX employs the order book model. Platforms for Automated Market Makers (AMMs), such as Pancake Swap and Uniswap, are a relatively recent innovation. The pricing methodology for AMMs differs from that of traditional smart contracts. Tokens can be traded between buyers via a “liquidity pool.” The liquidity providers who supply the funds charge a transaction fee to all users of the pool.
Over-the-counter
At the opposite end is OTC (off-exchange) trading. Financial asset and security brokers, traders, and dealers trade directly. Spot trading on the OTC market involves many communication channels.
OTC trades offer the uncommon benefit of no order book limits. Slippage is typical in low-liquid assets like small-cap currencies. Sometimes the exchange cannot fill your order at your desired price, forcing you to accept higher prices. Thus, large OTC transactions often enjoy better pricing.
Even highly liquid assets like Bitcoin might drop if orders are too large. Therefore, OTC trading can benefit huge BTC orders.
How Do Futures Markets Differ From Spot Markets?
As we’ve already established, rapid transactions and nearly immediate delivery are features of the spot market. In contrast, the futures market focuses on deals with indefinitely delayed payments. In a future deal, the buyer and seller have agreed to exchange X number of products for Y price. On the settlement date, when the contract comes to an end, the parties usually settle for cash instead of delivering the asset.
Read What Are Forward and Futures Contracts? to learn more about futures.
Difference Between Spot and Margin Trading?
Some spot markets allow margin trading, but this is not the same thing. Spot trading, as we’ve already established, calls for an immediate, all-in purchase and delivery of the underlying asset. Margin trading, on the other hand, permits you to borrow money from a third party at interest in order to make greater investments. Therefore, a trader who uses margin has the opportunity to make much larger earnings. The risks increase, however, so you need to be careful not to lose the whole initial investment.
Advantages and Disadvantages Of Spot Markets
You will find advantages and disadvantages to every trading method and approach you encounter. If you have a firm grasp of these, you may trade with less anxiety and greater security. Even if it’s one of the easier methods, spot trading still has its advantages and disadvantages.
Advantages of Trading in Spot Markets
- First, the market determines prices based only on supply and demand. In contrast, the futures market typically has several different standards of value. A number of factors, such as the financing rate, price index, and Moving Average (MA) Basis, go into deriving the mark price in the Binance futures market, for instance. Interest rates may also play a role in determining the markup price in some classic marketplaces.
- Second, the rules, rewards, and risks of spot trading are all easily understood. You may quickly determine your exposure when purchasing BNB on the spot market for $500 by dividing your entrance price by the current price.
- Third, it’s a “set and forget” situation. When engaging in spot trading, as opposed to derivatives or margin trading, you are not subject to liquidation or margin calls. Anytime you see fit, you can enter or leave a trade. In addition, unless you often engage in low-value transactions, you may forget to monitor your investment.
Disadvantages Of Spot Markets
- Dealing on the spot market might be risky since you might acquire items that are complicated to store. Stocks are a good illustration. Deliveries of crude oil are obligatory for spot purchases. It is the responsibility of the token or coin holder to protect their digital currency. Investors can obtain exposure to underlying assets through futures derivatives, which settle in cash.
- Certain assets, people, and businesses benefit greatly from consistency. A business that wants to expand internationally, for instance, needs to be able to trade in foreign currency on the forex market. Spot market trading would make budgeting and income projections highly risky.
- Spot trading has substantially lower profit potential compared to futures trading or trading on margin. With the same amount of capital, you can take on more risky trades thanks to the use of leverage.
Conclusion
One of the most prominent ways to trade, especially for newcomers, is through spot trading on spot markets. It’s simple, but it helps to have a thorough understanding of the benefits, drawbacks, and options available to you. You shouldn’t stop with only the fundamentals; think about rounding up your understanding using technical, fundamental, and sentiment analysis.