Spot trading takes place on crypto exchanges, enabling users to place market or limit orders to buy or sell a specific crypto asset at the current market price or a price they specify.
This method is favored by both individual and institutional traders who seek to own the actual crypto asset and avoid speculation on its future price movements through riskier products such as derivatives.
Spot trading is the most straightforward method for growing a portfolio. Owing to its key advantages, it is especially well-suited for beginners.
These include directly owning assets bought on the market, eliminating the risk of position liquidation during market downturns, and providing access to various trading pairs.
CEX vs. DEX
There are primarily two types of venues where traders can buy crypto assets — a centralized exchange (CEX) or a decentralized exchange (DEX).
Centralized exchanges are popular due to their user-friendly interface, rapid trade execution, and the substantial liquidity offered by market makers.
However, this efficiency comes with a trade-off. Although spot trading on a centralized exchange (CEX) delivers optimal performance, users must hand over their private keys to the exchange and entrust them with the custody of their funds.
On the other hand, spot trading on a decentralized exchange (DEX) provides users with complete control over their crypto assets, allowing for self-custody, albeit at the expense of performance and user experience.
Buying crypto on a DEX requires more steps and knowledge, but it allows users to self-custody their funds using a decentralized wallet such as Phantom or Rabby.
Refer to this article for more information about exchanges and how they operate.
Order book vs. AMM
An order book is a real-time display of buy and sell orders for a specific asset. It reflects the current market demand by showing the price and quantity that the buyers are willing to pay and sellers are willing to accept.
When combined with deep liquidity from market makers and an in-house matching engine, the order book provides spot traders with optimal execution, which is precisely why centralized exchanges adopt this model.
Kraken Pro interface
On the other hand, the AMM model was explicitly designed for the price discovery of crypto assets directly on the blockchain.
Unlike an order book, the AMM model combines a pair of assets in a liquidity pool to serve as a decentralized market maker, substituting traditional market makers and eliminating the need for a matching engine.
This is made possible by a formula (XY = K) embedded into a smart contract, which determines the price of paired assets.
While lacking granularity, this model greatly benefits assets with lower volume and liquidity, such as meme coins, allowing spot traders to buy and sell assets even when there are no active bids or asks at a given price point.
Uniswap interface
In summary, order books benefit advanced traders, whereas the AMM is favored by newcomers or traders looking to buy their favorite dog-coins that are not yet listed on a CEX.
Why should you choose to buy via the spot route?
Due to the considerably higher volatility in the crypto market, spot trading is widely recognized as the preferred choice for traders looking to grow their portfolios, as it removes the risk of position liquidation associated with futures trading.
Moreover, spot trading pairs are generally the initial ones to be listed on a centralized exchange and are almost always accessible on a decentralized exchange beforehand. This allows traders to invest in a crypto asset before it becomes available for purchase via a derivatives product like futures.
In essence, spot trading offers the best risk-to-reward ratio for most traders looking to invest in the crypto market.
