When people compare the stock market with cryptocurrency, they’re usually referring to the trading aspect and the returns. Both are traded on exchanges, and technical analysis principles from trading on the stock market can easily be transferred and applied to cryptocurrency trading, and vice versa. Both cryptocurrencies and stocks are also considered high risk, high return investments. However, both are fundamentally different..
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Differences between crypto and stocks
- Shares of a particular stock represent a share of the value or at least the perceived value of a company. The sale of shares provides liquidity to companies, and allows them to grow and prosper. Investing in the stock of a company entitles you to a “share” of its profits.
- Cryptocurrency in its original intent was created as a safe, decentralized alternative digital currency to facilitate transactions online, but without the need for intermediaries or third parties, like payment processors or banks.
It’s easy to understand what the underlying value of a company is. If a company is profitable and experiences growth, it means the value of the shares increase over time. You can, for example, check the ratio of a company’s stock price & its earnings (the price-to-earnings, or P/E, ratio) to get some insight into the financial situation of a company. Of course, sometimes future expectations determine price (or hype), e.g. biotech companies, and not so much the current underlying fundamentals.
What determines the value of a cryptocurrency?
It’s much harder to put a price on the value of a particular cryptocurrency. Value is ultimately what people are willing to pay for something, and cryptocurrency is no exception. The demand determines its price. This demand depends on various factors, here’s a list of some of those factors:
- Cryptocurrencies, unlike fiat money, are capped at a certain number. The supply is limited, and thus less prone to inflation compared to fiat currency or dilution when compared to stocks.
- Perceived future adoption and usefulness (e.g. ETH, LINK, ADA…etc.)
- The current adoption rate (e.g. adoption of XRP by banks for financial transactions)
- News and (social) media (e.g. DOGE and Elon Musk tweeting).
- The underlying technology and concepts behind it. (e.g. blockchain)
- Hype and speculation (meme coins)
- Introduction of new coins on major exchanges and trading competitions or other forms of promotion.
- Node count and creation cost, the cost of creating and maintaining the coin is going to be factored into its price.
- The demand for Bitcoin tends to influence the demand for other cryptocurrencies…etc.
Some people erroneously compare crypto to a Ponzi scheme because it’s “not backed” by anything, while forgetting that fiat currency isn’t backed by anything tangible either. Nor would anyone ever refer to gold or silver as Ponzi schemes, even if a rush for gold would drive the price to insane heights. Rather than comparing cryptocurrencies to fiat currency, it actually makes more sense to compare it to scarce commodities, like gold or currency backed by gold.
Every technology goes through different stages and in each stage you have more and more people supporting the technology (Diffusion of innovations, prof. Everett Rogers). And this also applies to Bitcoin and cryptocurrency in general.
Crypto is still in the early phases, with only innovators and early adapters flocking to it. It’s where the internet was at the height of the dot-com boom. Back then, the investment frenzy by venture capitalists eventually caused the collapse of the tech stocks in 2000. But the companies that survived the crisis are now some of the largest companies in the world, e.g. Amazon, Google, eBay.
The crypto space is maturing, and it’s not only about a decentralized digital currency anymore, there is a plethora of innovative projects. Let’s take the well-known cryptocurrency Ethereum as an example. Ethereum is a programmable blockchain, this means Ethereum facilitates more than just payments. Ethereum has created a programmable blockchain that enables developers to create and operate decentralized applications:
- Decentralized finance (DeFi) applications are creating an alternative financial system with products that let you invest, borrow, save and trade without the need of central financial third parties. Examples are loans where users can borrow against their crypto holdings or lend out their holdings in return for interest.
- Non-fungible tokens (NFT) are tokens used to represent ownership of unique items with unique properties and powered by smart contracts. In the near future, you might sell your house or car by exchanging an NTF for ETH, where the NFT acts as a deed. But also ownership of digital assets, like domain names…etc.
- Decentralized autonomous organizations (DAOs) are member-owned communities without centralized leadership. This solves the need for a treasurer and the associated trust it requires, and creates more democratic and transparent organizations. Charities, for example, could benefit from extra financial transparency, and the collective decision making on how the money is spent, all secured by smart contracts.
And this is only the tip of the iceberg. There are countless other projects in different domains. Cryptocurrency is not just digital money, it is a complete paradigm shift in the same way the internet changed the world forever.
Differences between crypto trading and stock trading
Shares are traded on an exchange, like the NYSE, and a broker acts as an intermediary between the end user and the exchange. With cryptocurrency, you can exchange coins with another buyer or seller directly without the need for a third party, or you can trade on a cryptocurrency centralized or decentralized exchange. In crypto the exchange is usually also the broker and vice versa.
Trading hours
The stock market is usually open during business hours and closed at nighttime, on weekends and specific holidays. The crypto market, on the contrary, is open 24/7, even on holidays. The physical location of the stock market determines its opening hours, for international traders, this is often not ideal due to the time differences. Cryptocurrency on the other hand never sleeps and sudden fluctuations in price can happen at nighttime, making it much harder to keep track and react to these price movements without using automated tools.
Regulation
Different government agencies highly regulate stock markets, while cryptocurrency markets are largely unregulated. Laws regarding the legality of cryptocurrency and cryptocurrency trading also differ from country to country.
In the US, the Securities and Exchange Commission (SEC) oversees the securities industry. It also registers new securities and handles all the filings from public companies. The Financial Industry Regulatory Authority (FINRA), a self-regulatory body, enforces rules that apply to brokers, broker-dealer firms. On top of that, you have the exchanges who also investigate fraud and abuses on their own.
Despite its popular use, cryptocurrency is still a new technology when it comes to regulations. Some efforts have been made regarding the taxation of crypto and the use of crypto in money laundering or as securities but when it comes to trading and the use of blockchain there isn’t a consistent policy in most countries. A lot of countries are also trying to find the perfect balance between fostering innovation and protecting its citizens from fraud and financial crime.
While insufficient regulation is generally considered undesirable from a consumer perspective, this lack of regulation is not always harmful. It often allows for innovation to bloom, and opportunities to arise in the absence of regulations, that might otherwise hamper its adoption. Cryptocurrency, for example, has significantly reduced the cost of sending overseas workers’ remittances to family abroad bypassing otherwise costly money transfers.
Safety & Market integrity
To be listed on the stock market, companies follow certain requirements and pay an application fee to be considered for listing. Listing requirements for crypto are less strict and thus not always indicative of quality, but usually also involve an application fee, especially for newer projects.
Both stock market and cryptocurrency exchanges require KYC (know your customer) and have 2FA (two-factor authentication) or phone number verification to protect the customers’ account.
Due to the highly regulated nature of stock exchanges, you can take legal recourse when things go wrong. With crypto, you are more often than not dependent on the goodwill of the exchange.
The often heard comment “cryptocurrency is mostly used for illegal activities” is also unfounded. The blockchain actually makes tracking of transactions more transparent than using cash. Yet nobody questions the US dollar, even though most drugs related crimes and terrorism are funded with US dollars. Cryptocurrency however behaves more or less like cash. Once it’s transferred, the transaction, unlike a payment with a credit card or a bank transaction, can’t be reversed unless the receiving party agrees to refund the money. This property makes it an appealing target for criminals. Due to this, it often gets a bad rap, but if you consider the amount of transactions that take place on a daily basis, it’s largely unwarranted, and transactions can be tracked on the blockchain. Reputable crypto exchanges also blacklist cryptocurrency reported as stolen.
The stock market, contrary to the popular belief, does not automatically guarantee a fairer market despite its many regulations. Not everyone on the stock exchange plays by the same rules (e.g. hedge funds, high frequency traders, market maker…etc). Manipulation is also rife with penny stocks but also with higher cap stocks. Recently, GameStop (GME) became a target for Reddit users that acted in unison against short positions (held by hedge funds) by buying shares and call options, thus triggering a gamma-squeeze. None of the regulations prevented the overzealous shorting by the hedge funds nor the concerted attempt by Reddit to provoke a gamma-squeeze. Having rules doesn’t necessarily mean they will be respected.
Costs
Trading and deposit fees are generally lower for cryptocurrency than for stocks but may differ from exchange to exchange when it comes to cryptocurrency and between brokers and exchanges when trading stocks. Low cost brokers such as Robinhood offer fee-less trading access to both stocks and crypto but primarily make money by selling users’ trading data to high frequency trading firms. This is called “payment for order flow”, or PFOF. This way the high frequency traders gain an unfair advantage and can front run the retail trades. They’ve also been caught halting trades and selling off positions. Free is always comes at a cost.
API integration
Almost all cryptocurrency exchanges allow for the integration of external applications into their exchange through an application programming interface (API), fueling innovation such a trading bots, portfolio balancers and trackers. These innovations allow you to automate your trading and investment strategies through the use of algorithms. This in turn increases liquidity and reduces volatility for trading pairs. This is not as common among stock brokers.
Returns
The average stock market return for 10 years is 9.2%, according to Goldman Sachs data for the past 140 years. The S&P 500 has done slightly better than that, with an average annual return of 13.6%.
- If you invested $100 in the S&P 500 at the beginning of 2013, you would have $299.47 now, under the assumption you reinvested all dividends.
ROI = 199.47%
- If you invested $100 in Bitcoin at the beginning of 2013, you would have $425,733.12 now, under the assumption you didn’t sell or trade until now. (https://dqydj.com/bitcoin-return-calculator/)
ROI = 425,633.12%
It’s not hard to understand why cryptocurrency has become so popular among investors.
Conclusion
Both the stock market and cryptocurrency markets offer attractive investment opportunities and should both be considered complementary rather than competing. Cryptocurrency cycles are also unrelated to stock market cycles, making it appealing as a hedging option. Not only is it immune to traditional stock market cycles, in Argentina and Venezuela it has also been adopted to battle the rampant inflation. Investing in cryptocurrency is thus not only a worthy option to hedge your portfolio against market downturns and create a more diversified portfolio, but it also offers protection from inflation.
