October 23, 2018

Crypto-to-Crypto Exchange: 4 Factors to Consider

Gold bitcoin coin.

There are two ways to swap cryptocurrencies for each other.

You can swap the old fashioned way by selling out your position in Crypto A and buying an equivalent amount of Crypto B. This is the way traders have done business since the first warlord stamped his face on some money, and it still works pretty darn well.

The second is to remember the “currency” part of cryptocurrency and buy your tokens of Crypto B with your tokens of Crypto A. This doesn’t always work, but when possible, you can cut out the dollar entirely and swap tokens directly.

Either way, when exchanging one type of cryptocurrency for another, there are a few things you should keep in mind. 

Tax Liability

If the cryptocurrency you are trading away has increased in value since purchase, you will owe taxes.

Through the end of 2017, traders and lawyers debated whether a crypto-to-crypto swap triggers a taxable event. Since the IRS treats Bitcoin as property, not an investment, many lawyers argued that swapping cryptocurrencies fell under Section 1031 of the tax code governing “like-kind” exchanges.

This law allows two parties to swap substantially similar property without generating a tax liability in the process. It has long been an ill-defined feature of the tax code largely intended to keep Americans from having to record every bargain or deal they make during the year.

There is no longer a debate. The 2017 tax bill restricted like-kind exchanges only to real estate (for some reason). An American who swaps tokens directly will now trigger a taxable event and must include the transaction on their filing.

Volatility Trading

One of the best reasons to directly swap tokens is for what traders call “volatility trading.” This is the practice of trading against two assets' movement relative to each other. It can be highly profitable, but it also generally involves fairly narrow margins for error.

Take a Bitcoin/Ethereum swap. Volatility trading means that you would take a position based on the two currencies' movements relative to each other and the dollar (or whatever your baseline currency happens to be).

There are many ways to trade against volatility. For example, say the price of Bitcoin goes up by $1 and the price of Ethereum decreases by $1. If you think that Ethereum is primed to bounce back up, you would trade in. This would net you a $2 per token increase in the amount of Ethereum you could buy, leaving you holding more when the price increases. (Of course, it also leaves you holding more of a steadily declining asset if the price keeps going down.)

Token-to-token exchanges work well for volatility trading because of speed and fees. This is a form of trading that tends to move quickly, sometimes with results measured in hours or even minutes. And it usually involves a lot of trades to make real money. Having to buy dollars then tokens would double your transaction times and fees, all of which could quickly add up.

Exchange Restrictions

Always pay attention to your exchange.

The moving pieces of any trade differ based on which exchange you use. Transaction times, whether you trade directly or through an intermediary, the fees involved, and (critically) what tokens you can trade for each other will all differ.

That last is one to particularly watch. It won’t help to line up the perfect moment for a Lisk/Pundi X swap if your exchange doesn’t have anyone making that trade.

Know your exchange, and make sure to factor it into your trading strategy.

FOMO

Finally, do not fear missing out.

Many cryptocurrency blogs advise investors to never cash out all of their holdings in a given currency, just in case it goes to the moon. This is bad advice.

That’s not to say put all your eggs in one basket. If you’re here to invest, you should absolutely have a diversified portfolio. No one wants to throw a party with just one guy, even someone as awesome as Bitcoin Johnson. So treat your e-wallet like a little black book and stock it with phone numbers for a Saturday night.

But that’s not the same thing as “consider always holding a bit of each coin you trade” just in case “one coin takes off.”  

Trade deliberately. If you make a trade, do it. Don’t have a fraction of a position spread across dozens of different cryptocurrencies all just in case one of them shoots upward. This is fear of missing out, and it’s a terrible trading strategy.

Yes, you might miss a big run. That’s fine. Slow down, breath, and get back to trading. There’ll be another. 

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