Trading on Ethereum step by step

1. Introduction

Smart contracts reduce the need for reliance on human enforcement in contracts. Often, they are more secure, less costly, and lead to a positive future for the role of automation in contracts.

An obvious example is in a complex financial contract. Suppose you loan some money to a friend, and he agrees to repay you by a certain date. If he does not repay you, he has broken the agreement, and you will need to employ a costly and time-consuming process involving lawyers and the legal system to get your money back. If the loan was in cryptocurrency, it is now possible to set up a smart contract. This would work in the same way. It would hold the money loaned, give it to your friend based on certain conditions, and return it to you if the conditions are not met. The contract can be accessed at any time, and it does not cost extra to run the enforcement code. Since the contract is self-enforcing, it will automatically return the funds to you if the condition is not met.

Smart contracts aim to automate at least some portion of this process, trying to replace the role of a traditional contract while minimizing failure. The smart contract does this by taking a code-based approach to the work of the law. They define a set of rules and penalties for a certain type of agreement, then carry these out in an automated fashion.

In the past, words and agreements (the contract) were usually enforced by law and carried out by a human enforcer. However, this costs time and money, and often the cost of enforcing the contract is worth more than the contract itself. In a worst-case event, the contract can be broken and there is no way to reverse the damage.

Ethereum is one of the most fascinating inventions created in the field of cryptocurrencies. Often described as a “world computer”, Ethereum is the first platform to execute smart contracts. A smart contract is a highly self-automated computer program that can carry out the terms of any contract. This platform is secured by an international network of “nodes”, each of which enforces the program.

1.1. What is Ethereum?

Ethereum is a decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, fraud or third party interference. These apps run on a custom-built blockchain, an enormously powerful shared global infrastructure that can move value around and represent the ownership of property. This enables developers to create markets, store registries of debts or promises, move funds in accordance with instructions given long in the past (like a will or a futures contract) and many other things that have not been invented yet, all without a middleman or counterparty risk. The project was bootstrapped via an ether pre-sale during August 2014 by fans all around the world. It is developed by the Ethereum Foundation, a Swiss nonprofit, with contributions from great minds across the globe. The Ethereum Virtual Machine makes the process of creating blockchain applications much easier and efficient than ever before. Instead of having to build an entirely original blockchain for each new application, Ethereum enables the development of potentially thousands of different applications all on one platform.

1.2. Importance of Trading on Ethereum

Aside from the capabilities of Ethereum, smart contracts have piqued the curiosity of the general public. This has been witnessed by the massive inflow of investments poured into ICOs over the last 2 years. These ICOs issue tokens built on the Ethereum platform and are purchased through smart contracts. The importance of Ethereum is accentuated by this fact, as the ERC20 tokens that are used for smart contracts are the lifeblood of the ICO itself. This has brought on a snowball effect where the more ICOs that are issued on Ethereum, the higher the price of Ethereum will move. With the recent surge in pricing of GPUs, gamers may have been disillusioned as mining has become less cost efficient. However, it is a great subsidized income for those who have purchased high-performance computing equipment. Subsequently, it is likely that traders will flock to Ethereum as the next “big” thing, much alike how traders flock to USD during Forex trading as the USD becomes stronger. This is further supported by the fact that there will be a switch to a new “proof of stake” algorithm which will mean that mining will no longer be a viable option, and all that has been mined can be traded on the open market.

2. Getting Started with Trading on Ethereum

Software wallets are the most commonly used form of an Ethereum wallet. They are accessed through the web or through a download and are often free provided you’re willing to include a nominal fee with your transaction. Software wallets are relatively safe; they can be reinstalled upon file corruption or loss with a restoration of the user’s saved private key. Private keys, when stored, are encrypted, and deletion of the software leads to destruction of your saved key data. The downfall with software wallets, however, is that they are accessible from any internet-connected device and due to this, leave the wallet vulnerable to potential hacking. An example of a software wallet is the Ethereum Wallet, also known as the Mist Wallet. This wallet requires the user to download the entire Ethereum blockchain (similar to how Bitcoin Core requires the download of the Bitcoin blockchain) and therefore may take several days to install. Mist will provide the user with a number of options, such as creating a wallet, backing up data, and sending or receiving Ethers. Another great option is MyEtherWallet, which is an online-based software wallet. This wallet is highly recommended due to its simplicity, easy-to-use UI, and active customer support. Another option is to use an exchange-provided wallet, however, in this case, the user must be cautious of potential scam exchanges.

There are 3 main types of wallets available for Ethereum. These are Software/Web Wallets, Hardware Wallets, and Paper Wallets.

2.1 Setting up an Ethereum Wallet

The first thing you’re going to need to start trading Ethereum is an Ethereum wallet. An Ethereum wallet is where you can store Ethereum, monitor your balance, and initiate send transactions. There are countless ways to get hold of an Ethereum wallet, however, I will run through the 3 main methods that are most commonly used.

Trading Ethereum immediately opens up the very high profit potential of the cryptocurrency markets, however it’s also a high-risk venture, especially if you have no previous trading experience. In this article, we will look into the less risky strategy of investing in Ethereum. This entails buying Ethereum with the intention of holding (hodling) a mid to long-term position with a view of increased value at a future date.

2.1. Setting up an Ethereum Wallet

The first type of wallet is a desktop wallet, and the most common type of desktop wallet is Mist. Mist is the official Ethereum wallet, and it takes a while to sync to the blockchain, but it is a full node wallet meaning that you are downloading the entire Ethereum blockchain, which in turn helps to make the network more decentralized. By downloading the entire blockchain, it verifies each and every block and transaction, which helps to ensure everything is accurate and nothing suspicious is going on. The next type of wallet is a mobile wallet, and this is the simplest yet least secure way to store your Ethereum; all you have to do is download an app and install it. The most common app is the Jaxx app, which allows you to store several different types of cryptocurrency, but you should carefully check app reviews as well as legitimacy claims that the app has not been tampered with.

In order to trade on Ethereum, the very first thing you need is an Ethereum wallet. Everything that you trade as well as the gas fees for transactions to trade go through the wallet. If you are using an exchange, you are most likely already aware that they provide their own internal Ethereum wallet and it is the default wallet when trading. This means that you can just go directly to trading with the exchange’s wallet. However, if you are going to be serious about trading, you most likely want to have complete control over your wallet and a greater sense of security. Having an Ethereum wallet as well as the private keys to it will allow you to directly interact with any smart contracts as well as using third-party websites such as MyEtherWallet or EtherScan. There are four different types of wallets and they all have their own advantages and disadvantages.

2.2. Understanding Ethereum Tokens

This can be confusing to understand, so to put it in simpler terms, the Ethereum network is a huge pot of land, and there is a specific area where each category of cryptocurrency is stored. However, all the different areas can only be accessed from one road, which is the Ethereum network. Now think of the Ethereum network ERC20 token as a sign in the ground labeled to determine what lies ahead. ERC20 is a technical standard used for smart contracts on the Ethereum blockchain for implementing tokens. It is a list of rules that developers must adhere to in order for their token to be created and executed on the Ethereum blockchain. The standard includes rules like how the tokens are transferred between addresses and data access possibilities. Esteems allows for seamless interaction between different tokens and the various different applications that want to make use of the token. Anyone can create a token by paying the ether (ETH) in exchange for issuing it, which essentially registers the new cryptocurrency onto the Ethereum network. Note that tokens will only be held in an Ethereum address that has been generated from using the Ethereum wallet. A new address cannot be generated, nor can tokens be stored in another cryptocurrency wallet. Therefore, sending any form of cryptocurrency on the Ethereum network all begins from the same road. But when the person wishes to turn it back into a different form of cryptocurrency, the person just needs to turn off at different points. One must be careful today, Ethereum still supports the original Ether, which is labeled as ETH, the only form of cryptocurrency that can be freely traded for different cryptocurrencies. This has caused many people to buy the newer form of Ether thinking that it is the same thing. As mentioned before, any cryptocurrency can create their own cryptocurrency, and many have been charging their tokens into the newer Ether forms. Steps are being undertaken to try and clarify the differences between these forms of Ethers.

Ethereum has its very own cryptocurrency called Ether. Some may know that the cryptocurrency is used to pay for gas, a unit that measures the amount of computational effort needed to execute operations or perform tasks, as well as smart transactions and simple transactions. Besides Ether, that’s only the start of cryptocurrencies on Ethereum. The answer is that there can be an infinite amount of cryptocurrencies on the Ethereum network. Let’s think of Ethereum like the internet and Ether like the US Dollar. Right now, you can use the US Dollar to pay for a variety of goods or services. But what if the US Dollar could only be used to pay for some things, like how things work for the currency in certain video games? This is a lot more similar to what the situation is for cryptocurrencies on the Ethereum network. There are specific cryptocurrencies used for specific applications. Some examples are Augur REP, which is used for creating a market forecasting tool, SingularDTV’s SNGLS, which is used for creating a decentralized entertainment industry, and DigixDAO’s DGD, which is used for creating a gold-backed cryptocurrency. These cryptocurrencies are also referred to as crypto commodities because they are sold on the cryptocurrency market. But the main problem arises when requesting these cryptocurrencies. What if someone accidentally sent SNGLS to their wallet where DigixDAO is stored? This is where the ERC20 token standard comes into play. Any cryptocurrency can create their own cryptocurrencies using the Ethereum network. But these tokens can only be stored in Ethereum wallets.

Section 2.2 Understanding Ethereum Tokens

2.3. Choosing a Reliable Exchange

GDAX is run by the same company that owns Coinbase, the enormously popular and simple-to-use cryptocurrency brokerage service. Coinbase has a phenomenal reputation with first-time buyers, so GDAX represents a fantastic step up in terms of security and simplicity. GDAX is intended for professionals who have experience with technical analysis and charts. It is somewhat complex for new buyers but has very user-friendly fees. From GDAX, you are able to deposit your fiat currency directly, avoiding the roundabout way of buying through Coinbase and depositing.

When it comes to buying or selling Ethereum, the exchange you choose can be one of the most important decisions you make. At this early stage in Ethereum’s development, there are several options for trading digital currencies. However, the cryptocurrency space is notoriously treacherous, so it can be no mean feat to find an exchange that is both safe and trustworthy. This guide will teach you what to look out for when choosing an exchange. At the time of writing, the only exchanges with a business track record are GDAX, Bitfinex, and Kraken. This post will focus on these three exchanges, although it should be noted that, at present, trading Ethereum through an established exchange is still in its infancy. Prices can be quite volatile, and it is not uncommon to see substantial price differences between different exchanges.

3. Strategies for Successful Trading on Ethereum

The best thing about trend analysis is that it is not difficult to learn and is a very effective method for predicting the future direction of a currency. If you were considering a long-term trade and noticed that the price of Ethereum seemed to always revert back to an upward trend, you could make a safe assumption that it was wise to buy. In contrast, if you were considering a short-term trade and noticed that the price was in a downward trend, you could open a position to sell high and buy back at a lower price. Trend analysis is a useful strategy for all types of traders.

Technical analysis is based around the idea that all information about the cryptocurrency and its price movements are already reflected on the price chart. This is the complete opposite of random walk theory, which claims that price movements are completely random and cannot be predicted. There are several ways to perform technical analysis, for example, Elliot wave theory, Dow Theory, or Gann theory, but the most basic method is to use trend analysis. This involves studying trend lines that connect historical price movements. This is a good method for predicting the future movements of Ethereum, as trends tend to repeat themselves.

When it comes to trading, be it stocks, cryptocurrencies, or anything else, one of the most important aspects for success is having a strategy, and this is no different for trading on Ethereum. Having a strategy for how you will trade Ethereum is crucial in order to maximize the chances for success. Ethereum trading can be very volatile; prices can fluctuate up and down on a daily basis. It can also be long term and short term. These are all factors that need to be considered when forming a strategy. Because of the volatile nature of Ethereum trading, there is potential to make high gains, but equally the potential to make high losses. One of the best methods to try and maximize gains while minimizing potential losses is through technical analysis.

3.1. Technical Analysis for Ethereum Trading

When markets move, they often move in a certain direction forming a trend. Whether it is the price of a specific currency, a share price, or even a market index, they often move in a particular direction. The random walk theory suggests that the market movements are random and it is not possible to predict future movements. However, there is also the alternative that market movements are determined and move in a direction, i.e. they are not random. If we can identify the direction of the market, we are then able to make profits on our trades, buying if the trend moves upwards and selling short if the trend moves downwards. This is essentially what trend following is.

A common technique used in trading stocks that can easily be applied to trading Ethereum is trend analysis. This strategy identifies the general trend that an asset follows and can be used to provide an indication of the general direction to take a position in the asset. Highs and lows of an Ethereum price over time form a line that can resemble a trend; while Ethereum prices have generally been identified as moving upwards, numerous two-way opportunities exist when considering Ethereum’s relative value to bitcoin during both currencies’ volatile price movements.

Similar to stock investing, various technical analysis tools are available in the cryptocurrency space. The technical trader uses the price history of a given asset to make informed decisions on the probability that the future price of that asset will move in a given direction. While this is considered to be less valuable in a young market with no price history and lower trading volumes, there are still opportunities to use technical analysis in the cryptocurrency space. Various altcoin markets have high volatility and can be an excellent testing ground for new traders. Additionally, technical analysis has a self-fulfilling nature to it; if a critical mass of traders are using the same tools and patterns, then these tools and patterns will become more effective.

3.2. Fundamental Analysis for Ethereum Trading

Dynamic analysis can then value Ethereum as a sequence of cash flows from its first release to the future predicted date of a firm investor. Cause and effect relationships are used to determine the most likely change in performance from the earlier static analysis and hence plan the best investment strategy. This prediction of the future price of an asset is essentially what all investors are doing in the financial markets, trying to buy or sell at the right time for maximum profitability. Static analysis can act as a foundation for dynamic analysis, reiterated if predictions change, and also be a tool to compare the investment of Ethereum with another alternative investment.

Fundamental analysis can be broken down into two types to make predictions on the future price of Ethereum or other cryptocurrencies. Static analysis attempts to determine a value for an asset at a specific point in time, while dynamic analysis bases valuation on a sequence of cash flows at a specified horizon. Static analysis would be most sensible for the valuation of Ethereum at present, as it has not stabilized and the rate of investing is unknown. Static analysis consists of forecasting the profitability and financial positioning of a firm. Ratios, such as the return on equity, are used to determine the positioning in the market and the quality of a firm. Investment in Ethereum is an investment in the future of the platform, so the clearer the future, the better the likely returns. Therefore, the analysis of future prospects and Ethereum development can be considered more important for the forecasted valuation of Ethereum. Static analysis will then assess whether future predictions are publicized and taken into account by investors, using cause and effect to change expected future performance with the investment.

Fundamental analysis is a tool that can be used to establish the intrinsic value of an asset to guide decision-making. The aim of fundamental analysis is successful trading, buying and selling an asset at the right time by accurately valuing it. It is based on the belief that the market is not efficient and that the price of an asset will move towards its true value. Ethereum is still in its infancy and there are a number of significant decisions that need to be made before firm foundations are built. This creates a large degree of uncertainty for the future of Ethereum.

3.3. Risk Management Techniques

“Smart” stop loss is a term used for an alternative stop-loss technique where a trader will cut his losses in a trade to avoid further loss of capital. The risk is seen to be too high in relation to further potential loss of capital. He can do this using margin trading and a more customized stop-loss position, but for this, we’d need to write a new post on margin trading! In a simple form, this can be done by closing all other Ethereum positions on the trade rather than sell all to Ether or worse, to fiat!

We have taken a look at how we can determine the risk and potential success of a trade by using both technical and fundamental analysis in order to pave the way for successful trades. An easy way to determine success is to make sure you don’t lose money; however, this is in many cases unrealistic. Trading is a calculated risk, so we want to minimize money lost on unsuccessful trades. One simple yet effective way to do this is to set a risk-reward ratio. With this, we can determine the size of the position we are open and the amount we are willing to make or lose on a trade. For example, if you are looking to short a run in the BTC/ETH price in anticipation of the token migration event, and technical analysis suggests the trade will carry a great degree of success, you may want to open a large position in the hope you can gain 30% more of Ethereum holdings. In saying that, you also want a safety net, so a stop-loss order can be placed above the point where your analysis is deemed incorrect. The stop-loss order should be placed where the analysis is deemed definitely incorrect.

A lot of people would read the above comments and think that 7 BTC is not much money to someone, but it really doesn’t matter. That is because risk is not a part of your account size, but a measure of the impact an unsuccessful trade will have on you both financially and mentally. If you have 1 ETH or 1000 ETH, the trading strategy should be unchanged. Failure to understand the effects of greed, fear, and the impact of risk can and have left many traders devastated with little capital to continue trading. DigixDAO and MakerDAO are projects built on the Ethereum blockchain where DGD and DAI tokens represent the value of gold and USD respectively. You can use these to peg your account value.

Risk management techniques are very important when trading in cryptocurrencies, including Ethereum. This is because, even though Ethereum is still a budding cryptocurrency and has less liquidity than, say, Forex, volatility is still very high and losses can be devastating without pre-planned risk management techniques. This is the voice of experience speaking. I remember a day trading session I had on Poloniex where, in a few hours, I made 10 BTC, drained away half of it looking for more, and then in one bad trade turned the rest into 1.5 BTC! At the time, that was an amount of money I was not comfortable with losing, and it impacted my trading going forward as I became more cautious and less focused on the task at hand.

3.4. Tips for Trading on Ethereum

3: Keep up to date with Ethereum’s platform progress and development. It is no secret that Ethereum is a work in progress. There is an abundance of information and resources regarding the progress of Ethereum’s development and its platform changes. Often times, platform changes and progress result in marketing and speculation. This makes it a great opportunity to trade on the token of a specific project, as project teams generally have a solid understanding of Ethereum’s technology and a connection to developers within the Ethereum community. It is important to clearly understand the changes being made, and sometimes this can lead to trading opportunities on the old token being converted to the new, and vice versa. Make sure to research sufficiently before attempting this kind of trade.

2: Don’t always chase the big money. A common mistake made by traders is their overwhelming desire to buy into a highly speculated and valuable asset, as they think it will be the most lucrative, believing they are too late to the party if they have missed the initial bull run. While “to the moon” style gains are possible, the higher the market cap and speculation levels of an asset, the higher the risk. Sometimes it can, in fact, be more profitable to invest in a cheap and undervalued asset with good fundamentals and wait for the speculation to catch up; SALT and LINK being recent examples of this. Set a target entry and always be patient.

1: Be on the lookout for ICOs launching on Ethereum. Ethereum is home to many upcoming projects and ICOs. In fact, during 2017, it seemed like a new Ethereum-based ICO was being launched every day. A lot of the time, when projects fundraise using ERC20 tokens, the tokens are still held in a smart contract on Ethereum and will not be tradable on exchanges for a period of time. This was the case for OmiseGo and, more recently, Kyber Network. There is often a substantial delay between the public crowdsale and the tokens being listed on exchanges for trading. Patiently waiting for the ICO tokens of promising projects can potentially be a long-term lucrative strategy. Of course, it also presents the opportunity to take advantage of impulsive sellers who are looking to unload their tokens for quick profit, or simply those who are unaware that the tokens are not yet tradable. In this instance, the token symbols usually serve as a prefix with “-” followed by the amount or number of that token. It is simple to add the token and custom symbol in the top right of the wallet and add a custom token to track your balance.

4. Advanced Topics in Trading on Ethereum

NFTs are the token in your Ethereum pocket that I’d imagine you won’t have come across yet. The acronym stands for ‘non-fungible tokens’. Now I’m aware that it’s best not to define terminology by using the word itself, but ‘non-fungible’ essentially means that it’s not mutually interchangeable. A simple example would be trading cards: if you had a specific card from back in your childhood in your possession today, you wouldn’t want to trade it for any card of the same type, even if they look identical. That card has sentimental value to you. Any instance of a token deemed an NFT has verifiable scarcity whether through its unique attributes or its quantity in volume. A good starting point would be to check out this deeper explanation of NFTs on Ethereum.

DeFi could have been the sole topic of a guide of this length, but for the time being, we’ll be concise by cracking on to smart contracts and automated trading. An elementary way of thinking about smart contracts is that they are automated, self-executing agreements with the terms of agreement written into code. If you’re unfamiliar with the concept, check our guide to understanding Ethereum.

Decentralized Finance intends to mirror all traditional financial services, but do it on the Ethereum network. Similar to traditional banking infrastructure, it has the intention to ‘replace the system’, but on Ethereum’s terms. Think loans, savings, trading, insurance, and more, but in a trustless, transparent, and secure manner. In essence, it’s all done via P2P using smart contracts; there are no intermediaries. Still a burgeoning movement, the main hubs for DeFi at the time of writing are Compound Finance, Aave, and MakerDAO; again this could change by the time you’re reading this.

Chapter 4 delves into the advanced topics in trading Ethereum. Specifically, it looks into the world of Decentralized Finance, smart contracts and automated trading, and NFTs.

4.1. Decentralized Finance (DeFi) on Ethereum

The concept of Decentralized Finance (DeFi) is a rug pull on the trust-heavy biased financial system proposing non-custodial financial services through utilizing the power of decentralization, moving away from central banks and into native blockchain services. DeFi has become a large part of the cryptocurrency ecosystem and has a large relevance to Ethereum. Often labeled as “programmable money,” DeFi initially asserted its dominance through the funding of Ethereum tokens via crowd sales known as Initial Coin Offerings (ICOs). This had a major impact on the Ethereum network, with gas wars becoming prevalent as projects competed to have their transactions processed quicker. This led to an increased ETH price and stress on the network. An increase in ERC-20 token development was also observed around this time period, where tokens were often staked or locked within smart contracts in return for interest or rewards. This has resulted in a large amount of token-specific DeFi markets and systems being developed.

– DeFi: non-custodial financial services – Initial concepts and ICOs – Decentralized exchanges and trading platforms – Centralized exchange services – The future of DeFi

4.1. Decentralized Finance (DeFi) on Ethereum

4.2. Smart Contracts and Automated Trading

In contrast to the relatively simple DeFi platforms, smart contracts provide a decentralized way to trade instruments that is trustless, often more liquid, and in many cases lower cost. Smart contracts are simply programs that run on the Ethereum network. They are called smart contracts because they run exactly as programmed without any possibility of downtime, censorship, fraud, or third-party interference. Ethereum smart contracts can represent literally anything from a financial derivative to an auction of an item. One of the key differences between smart contracts and DeFi platforms is that with smart contracts, each trade is executed directly between the two parties without any need for a counterparty to place trust in the safety of deposited funds. This is favorable to many investors who are hesitant to place funds on platforms that often suffer security breaches. A second key difference is that many smart contracts can be written to provide more complex use cases than the simple borrowing and lending, which is common among DeFi platforms. This opens up a wider array of trading instruments from options to complex derivatives. One such example of a smart contract trading platform is dydx. Dydx is a decentralized leverage trading platform that runs on smart contracts. With dydx, a trader can open a leverage long or short position on an asset using only an Ethereum token. The beauty of this is that the trader remains in possession of the token, and the leveraged losses are limited to the initial margin put down without the possibility of liquidation and loss of the entire token as is the case on DeFi leveraged trades.

4.3. NFT Trading on Ethereum

NFTs, or non-fungible tokens, consist of data within smart contracts verifying the digital asset’s uniqueness and ownership, and are a prominent use-case for Ethereum’s smart contracts. NFTs are typically used to represent digital or physical assets and are unique, from in-game items to digital art. They have an owner and certain attributes that are undisputably verifiable. As a result, NFTs enable new opportunities for trading on Ethereum than what has historically been possible with fungible tokens. One of the important distinctions between NFT trading and fungible token trading is the ability to verify ownership and attributes of the assets being traded. Backing every NFT is a set of on-chain data that can vary in complexity, but typically represents the asset’s metadata and attributes. This data often exists as a combination of on-chain and off-chain data, but it presents an opportunity to more deeply understand the asset you are trading, as well as the ability to display it in various ways across different applications. Because NFTs can represent anything, there is a wide variety of methods to display and interact with different NFTs. This has led to a burgeoning NFT ecosystem with a wide array of marketplaces, games, and applications centered around trading and interacting with NFTs. These range from NFT specific marketplaces like OpenSea to games like CryptoKitties, where acquiring and trading NFTs is a core mechanic.

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