The cryptocurrency world is embracing more aspects of the legacy financial system. The industry went from joining the bitcoin network and mining for fun and purpose to also bringing in more people to preserve value.
For instance, did you know that crypto futures trading is starting to become a more prevalent aspect of speculation today? Yes, the digital asset industry is becoming more interesting and sophisticated. It is not like the years of yore when people in the digital asset community had to find ways to ascribe value to bitcoin. Now, we have derivatives of digital assets to use to have a hand in speculation without having significant exposure to the respective asset.
Well funded international organizations such as Binance, Bitmex, and other respected entities offer trading in this format. Respected institutions such as the CME and CBOE also offer bitcoin futures, this was a large deal when it came out in 2017 and 2018. It meant that bitcoin was entering into a new era. These are just some of the institutions that offer these wonderful contracts.
Further, as they offer supply, they continue to see pent up demand and increase in contract consumption. It is not just retail traders but institutional interest in these complicated but fascinating financial vehicles as well.
There are benefits and drawbacks to derivatives such as cryptocurrency futures and it is best to understand them before proceeding. Let’s find out more about crypto futures trading and how it can be useful in your digital asset speculation journey.
What is Cryptocurrency Futures Trading?
To understand digital asset futures trading one must first comprehend the basic notion of futures trading.
Here’s the scoop.
Futures are financial agreements that are derived from a specific asset. They are called derivatives because they are based on something else as opposed to being direct transactions. Futures agreements require two parties to swap an asset in the future at a specific dollar value range. You agree now to enter into such an agreement in the future. A buyer of the contract will perform the action of acquiring the specific asset in the agreement. The seller will divest the asset at the specific dollar value range.
Both must adhere to what they stated in the past.
The winner is the one that guessed the price right. But what does that mean?
We will have to understand the fundamentals of the contract and the motivations behind it.
The Fundamentals of a Futures Contract
Let’s start with the motivations.
The first point here is that of uncertainty and worry about the future. Individuals and entities might hold onto specific assets and commodities and think that the future may hold great risk or volatility. If they think that assets or goods might rise significantly in value then they could decrease issues by stating to buy a good at a reasonable price. Now, they know that they can continue their business without issues. They have let go of their worries of price increases.
Let us take an example to understand even more clearly with the price of lithium. Tesla needs lithium for their current vehicles but think that the price might go up in the future. They would want to buy a futures contract that stipulates they can buy lithium for a reasonable price. The counterparty (the one who sells the contract) will agree and will supply lithium at that price.
The buyer is betting that the price will rise and wants to get it at a price below the future increase. The seller is one that thinks it will go down.
This contract works for both parties and people in different segments from gold to bitcoin.
Each contract consists of specific components:
- Trading hours – all assets have varying and unique hours of exchange
- Tick size – each asset can go up or down a specific tick size.
- Contract size – one agreement can state that one contract unit is equivalent to specific units in the good. Example, one unit of corn may always equal 100 corn bushels.
- Agreement Value – the value of the contract on the specific date of agreement. This is the size multiplied by the price.
- Delivery – will the good be delivered in a financial manner or physical manner.
Traders also appreciate futures because they allow them to control more value with minimal money upfront. But they carry a cost and that is what you must watch out for in the long term.
Alright, so how does this relate to cryptocurrency futures?
Well, crypto futures uses similar principles and lets one bring this to bitcoin, ethereum and other coins and assets. Bitcoin miners, hedge funds, and other investors in the network would want to make sure to minimize future risk and purchase bitcoin futures to smoothen out issues. Miners can buy it to increase the chances of a successful mining operation and prepare for expected bitcoin halvings.
How Does Crypto Futures Trading Work?
There are several ways to operate a cryptocurrency futures agreement. One way is to enter into a traditional agreement on a specific token. In a traditional agreement one party has a long position and the other one has a short position.
Both parties enter into the agreement and deposit the value through margin. If the price of the commodity or token were to move up, the seller who is betting against it would see a decline in value. This happens in an automatic fashion. If the market were to move down slightly, the buyer would see a decline in value in their account automatically.
Let’s look at a situation where two people enter into an ethereum futures contract. The buyer would deposit 1000 DAI to control 10,000 ETH futures with at least ten times leverage. This purchaser would have to process this transaction only on the specific platform. The seller would also deposit a certain margin sum and watch like a hawk.
For example, if you are utilizing Binance Futures, everything will happen on there and not on the regular Binance platform. As you know by now, futures may not deal with the actual currency but with the values that fluctuate around the underlying coin. The settlement of it may be in the actual currency if that is what is in the contract.
Stay updated on your trade by looking at your balance and seeing how the market moves. If the market moves in your direction, you will see the amplified gains or losses based on your position.
The cost here to control a large contract is the margin requirement and that is why people would opt to deal with it in such a manner. Further, both parties would enter into such an agreement because it gives them more options. For instance, if you have $3,000 to use to speculate, you can place $1,500 for futures agreement margin and then use the other half to buy digital assets regularly.
You realize the money when the contract expires or when you close it.
Potential Liquidation in Futures Contracts
The main component of the futures contracts is that of leverage and betting on the future with a little margin. The more agreements you have in the market the more exposure you have. With debt or leverage you will deposit the margin and use that to increase returns or losses.
The larger your amount of leverage the higher the chance of losing your deposit. If you want to go a 1000x, small moves will increase opportunity and add to your value or decrease it substantially.
It is essential to note here that different platforms will have different margin requirements and will act accordingly. For instance, if bitcoin went against you, they might close it out at 70% of loss of your margin while another might do so at 90% loss of your margin.
Are There Fees Involved?
Platforms will differ in how they approach this process but will charge a percentage for the acquisition and divestiture of agreements. This is akin to general and regular trades.
These platforms will earn money on those who choose to prolong an agreement past expiry. Interest costs are also a factor that one must watch out for in these trades. Input and extraction fees.
Why Do People Prefer Cryptocurrency Futures Trading?
These financial vehicles offer a sense of safety, security and optionality. Professional and novice traders can flock to these financial instruments because they can use them to hedge away risk amid extreme volatility.
These options are about bringing about simplicity and peace in times of great nail biting and stress due to crashes and pessimism. Digital asset futures contracts and trading lets traders hold onto a comfortable nook and minimize risks. Traders can increase gains with accurate stratagems.
They will continue to use this concept so that they can prepare for the future and gain if events were to turn against them. Savvy traders can gain from both sides of the market if they play it correctly.
What is the Difference Between Futures and Regular Trading
The fact is that each contract requires two parties that will opt for equivalent specifications. It only works if both parties agree to those specific terms. It allows for simplicity and the control of the right positions.
But in a spot or regular trade, the buyer and seller is exchanging the good at that present moment as is. The buyer in a spot or a regular trade will get bitcoin while the seller will get USDC or a regular greenback.
But if one were to come back to the futures arena, one would see a different equation. Each party must only allocate a bit of margin to their account to be in the transaction. Nothing is exchanged at first, the only thing that occurs is that the intermediary notes both parties enter and commit to the transaction.
Remember that the futures price will vary from the regular platform price. The reason is because of the time difference and other aspects involved in the futures agreement. Sellers of these contracts will want to minimize risk and will seek more or less coin based on the situational factors.
Okay, remember the issues we talked about earlier? Everything is not amazing with futures contracts. For instance, while it only requires a fraction of the total price of the contract, one must remember that they are using leverage. If you are wrong, you can lose more than your deposit because of debt in the transaction. Debt is a critical component that helps to provide massive gains or potential increased chances of loss.
For example, let’s say you want to buy bitcoin futures and think that it is going up. You will buy it and place a minimum margin requirement. You might place $5, 500 for a contract with a notional value of $100,000. As the transaction progresses, the platform might ask you to place more money for the maintenance margin.
The volatility is a blessing and a curse and so use it wisely.
Futures Platforms Might Have Restrictions
Remember that this option is not present everywhere for a few reasons. Crypto enthusiasts in the United States will have a few options to choose from while others may have a plethora of choices. Always peruse different exchanges to see if they are open to those who hail from the United States.
Providers must deal with regulations and stay transparent to stay afloat and in business. But you will see specific entities that are regulated and those that are less regulated.
Choose wisely as you want to deal with the best actors in this sector and preserve your money.
Profits in Crypto or Fiat?
Again, the providers might have it to where you see an increase in your cryptocurrency holdings or your fiat. It depends on the provider and the agreement.
Fiat or Crypto Collateral?
Providers might ask you to deposit cryptocurrency for the margin or fiat for the margin. The structure might vary from place to place.
Perpetual Vs. Futures
Why do people choose perpetual contracts over futures? These swaps were formed for digital assets and do not have any expiration dates.