Spot trading in crypto: A guide to immediate transactions

Not every crypto exchange gives you direct access to digital assets. In fact, many trading platforms focus solely on offering derivatives – contracts that provide price exposure to cryptocurrencies without actual ownership. 

Holding actual crypto in your wallet requires using an exchange that offers spot trading. Aside from peer-to-peer (P2P) platforms, spot exchanges are the most authentic way to interact with blockchains using decentralized technology.

In this guide, we'll explain the basics of the crypto spot market and how to determine if it's right for your strategy. We’ll also explain what a spot balance in crypto is and how it factors into your trading decisions.

The basics of crypto spot trading 

Crypto spot trading involves the direct buying and selling of digital assets. Acquiring cryptocurrency on its respective blockchain, like 1 BTC on Bitcoin or 1 ETH on Ethereum, constitutes a spot trade. This method means taking ownership of the actual digital asset, which can then be transferred from the exchange to a private wallet for secure storage.

Unlike other trading methods, such as margin trading, spot trading uses only the cash or crypto available in your account. This reduces the risk of liquidation, ensuring potential losses are capped at the amount you invest, though it may limit capital efficiency (compared to margin trading).

Crypto spot trading versus derivatives trading 

The primary distinction between spot and derivatives trading in the crypto space is that derivative transactions don’t involve transferring actual cryptocurrencies. Instead of exchanging digital assets directly, derivatives traders work with contracts that mirror the market price of an underlying cryptocurrency. Products like options, futures, and perpetuals allow speculation on price movements without the digital asset itself being in your account.

Another defining feature of derivatives trading is leverage, which lets you borrow additional funds to amplify position sizes and increase potential returns. While this feature enhances capital efficiency, it also raises the risk of liquidation when positions move unfavorably. 

How does a crypto spot transaction work?

The mechanics of a spot transaction can vary depending on the trading platform a crypto trader uses. Typically, a spot trade begins when a trader submits an order to buy or sell at the current market price. Once a crypto exchange receives this order, it matches the trader with a counterparty – someone willing to buy or sell at that price. When a match is found, the exchange settles the transaction by transferring the cash and digital assets between accounts.

Other spot trading platforms, like decentralized applications (dApps) or P2P protocols, bypass intermediaries and facilitate direct transfers of digital assets between self-custodial wallets. Regardless of the method, spot buyers always receive actual cryptocurrency in their accounts immediately after the transaction. 

Types of crypto spot transaction platforms 

While dedicated cryptocurrency exchanges are the most popular venues for spot transactions, they’re not the only way for traders to buy and sell digital assets. Other trading avenues – such as over-the-counter (OTC) trading and P2P platforms – offer benefits like increased privacy, greater control over transaction details, and potentially lower fees. These alternatives provide traders with flexibility, allowing them to tailor their trades to suit specific needs and preferences.

Cryptocurrency exchanges 

Trading on spot exchanges is a common way for users to directly own cryptocurrencies, but these platforms vary in their operations. How a spot exchange manages record-keeping, liquidity, and transfers depends on whether it uses a centralized or decentralized infrastructure.

Centralized exchanges (CEXs)

CEXs are company-operated crypto trading platforms where a third party oversees and facilitates trades. On a CEX, users trust the platform to securely hold their digital assets and execute trades on their behalf. CEXs typically collect personal "know-your-customer" (KYC) details to comply with local and international anti-money laundering laws, preventing illicit activities. 

In exchange for providing personal identification and relinquishing some control to the exchange, users benefit from high liquidity, a wide range of trading pairs, conveniences like bank account and debit card integrations, and potentially insurance coverage.

Decentralized exchanges (DEXs)

Rather than relying on a centralized order book, DEXs use blockchain technology, algorithmic programs, and smart contracts to facilitate peer-to-peer transactions. Each DEX operates as a software application on a blockchain like Ethereum (ETH) or Solana (SOL), allowing traders to connect their self-custodial wallets for direct transfers. On automated market maker (AMM) DEXs, such as Uniswap (UNI), traders exchange assets from "liquidity pools," which are funded by other users (or "liquidity providers") who earn a fee for each transaction. While DEXs don’t require KYC data or expose users to counterparty risk, they present a steeper learning curve, lack insurance protections, and carry risks of hacks and smart contract vulnerabilities.

Over-the-counter (OTC) trading

OTC trading desks are P2P platforms designed for individuals and institutions handling large volumes of cryptocurrency, often referred to as “crypto whales.” On an OTC platform, clients arrange to execute large-volume trades outside of an exchange’s public order books. Some traders prefer OTC spot transfers to maintain privacy and prevent large transactions from affecting the cryptocurrency’s market price. However, due to the substantial volumes typically involved, OTC providers set high minimum requirements and charge significant fees for these services.

Peer-to-peer (P2P) trading

Similar to DEXs, P2P platforms facilitate direct wallet-to-wallet transfers without relying on liquidity pools, allowing traders more flexibility to negotiate prices. For security, P2P platforms often use an escrow service to ensure both parties meet their obligations before completing the transaction. While P2P platforms provide diverse payment options and greater freedom, they can have slower transaction times, risk of scams, and may charge high fees for escrow protection.

Pros and cons of crypto spot trading

Spot trading offers a straightforward way to buy and sell cryptocurrencies, though it may not be ideal for every situation. Depending on your goals, time horizon, and risk tolerance, engaging with digital assets on the spot market might not always be the most effective approach.

Pros of spot trading

• Simple process: Spot trading is easier to understand than more complex contracts and synthetic derivatives. The basic process of exchanging digital assets and cash between accounts is a convenient entry point for new cryptocurrency traders.
• Accessibility: Many centralized and decentralized platforms provide easy access to spot cryptocurrencies, often with few barriers to entry. Once on a spot exchange, you can invest with as little or as much as you like.
• Direct ownership of assets: As mentioned earlier, spot trading allows you to claim full ownership of your digital assets. After purchasing a cryptocurrency like Bitcoin, you can transfer it to a self-custodial wallet, use it for purchases, explore decentralized finance (DeFi), or securely store it without relying on intermediaries.
• Low risk of liquidation: With no borrowed capital involved in the spot market, you avoid the risk of forced liquidation in adverse market conditions. In contrast, leveraged trading amplifies minor price fluctuations, potentially wiping out a trader’s portfolio.

Cons of spot trading 

• Bullish bias: Spot trading assumes that the asset will appreciate in value. Without tools to profit from price declines, you’re limited to holding assets, often waiting for an uptrend. 
• Limited hedging options: Spot trading doesn’t provide easy hedging opportunities. You must either hold through flat markets or buy at lower prices to average down. In contrast, derivatives allow you to hedge more flexibly and mitigate risks in your long-term portfolio.
• Full capital requirement: You also have to fund trades upfront, which means potential profits are limited by your available capital. However, this does reduce your risk compared to derivatives.

Keep crypto transactions spot-on with CoinTracker

With integrations to hundreds of CEXs, DEXs, and crypto wallets, CoinTracker provides a simple way to monitor your crypto movements. Whether you purchased an asset via spot trading or otherwise, our advanced software automatically detects and categorizes your transaction, including activities like staking, liquidity mining, and airdrops. When tax season approaches, CoinTracker makes it easy to identify tax-loss harvesting opportunities and generate IRS-compliant forms.

Get started with a free CoinTracker account and see how simple it is to visualize your digital net worth. 

Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.