Cryptocurrency futures trading is a type of investment that is gaining popularity among crypto enthusiasts. In this blog post, we will explore the basics of futures trading, how it works, the similarities and differences with margin trading, and the risks associated with this type of investment. Whether you are an experienced trader or a beginner looking to invest in cryptocurrencies, this blog post will provide you with valuable insights into futures trading and help you make informed decisions.
A Closer Look At The Mechanics Of Futures Trading
Futures are a type of derivative contract that obligates a buyer and seller of cryptocurrency to complete the transaction at a predetermined price on a specific date in the future.
Some crypto investors opt for futures trading instead of buying or selling directly, as it eliminates the complex processes and requirements involved in trading cryptocurrency. The terms of a crypto futures trade are defined in a futures contract, which requires the buyer to receive the cryptocurrency at a predetermined price on a specific date and the seller to deliver it under the same conditions when the contract expires.
Futures contracts are traded on exchanges such as the CME Group, the largest and most well-known globally, and are identified by their expiration month. In 2021, the Futures Industry Association (FIA) reported that 29 billion futures contracts were traded. Futures trading in cryptocurrency is gaining popularity, with more people interested in this type of investment. The CME reported a 13% increase in Bitcoin futures contracts and Micro Bitcoin futures being traded in 2021.
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The main advantage of futures trading is the ability for investors to hedge their crypto assets against price movements, reducing losses from negative price changes. This is achieved by taking a position opposite to the one held in the underlying asset. Although there is still a risk of losing money in futures trading, losses can be minimized due to the hedging element, making it less dramatic compared to margin trading.
To trade crypto futures, an approved brokerage account must be opened, like a margin account.
How Does Futures Trading Actually Work?
Futures trading in the cryptocurrency market allows investors to speculate on the price of Bitcoin without owning it.
In crypto futures trading, a contract is made between a seller who wants to lock in a price with the hope of making a profit at a specific date in the future and a buyer who will purchase the agreement as a hedge against paying higher prices if the asset appreciates in value. The process takes place regardless of the actual price of the asset at the future date and is regulated by futures exchanges that guarantee the fulfillment of the contract when it expires. Futures in crypto trading are typically quarterly or perpetual contracts.
Futures contracts must include the following elements:
- Expiration date – the date when the futures contract is settled at the predetermined conditions.
- Contract value – the amount of cryptocurrency that forms the underlying asset covered in the contract.
- Leverage – some exchanges allow traders to borrow funds to increase their position size and potential gains.
- Settlement type – this can usually be in cryptocurrency, cash, or through a bank transfer.
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Comparing Investment Giants: Margin Trading vs Futures
Investing in either margin trading or futures trading requires a certain level of expertise as both strategies are considered advanced techniques in the trading world. Despite their similarities in goal, the two investment tools differ in their approach and the markets in which they operate.
Margin trading takes place in the spot market, where immediate delivery is sought after. On the other hand, futures trading refers to trades in the derivatives market, where assets are to be delivered at a future date.
Similarities Between Margin Trading And Futures Trading
Opportunity – Margin trading and futures are alike in their purpose as investment tools. They aim to provide investors with the chance to purchase larger amounts of a crypto asset using only their equity. They are both speculative in nature and offer different approaches to achieving a common goal.
Purpose – Both margin trading and futures have the potential to generate amplified returns, but they can also lead to extreme losses. The cryptocurrency market can be highly volatile, making it possible to experience significant gains quickly. However, it’s also crucial to note that dramatic losses can occur, which is why it’s recommended that only experienced traders utilize these tools.
Differences Between Margin Trading And Futures Trading
Market Places – Margin trading and futures trading differ in the markets they operate in. Margin trading is conducted in the spot market, while futures are traded in the derivatives market with the expectation of future asset delivery.
Leverage – The leverage in crypto margin trading generally ranges from 5% to 20%, while futures often exceed 100% leverage.
Collateral Allocation – In crypto margin trading, traders can use a loan that requires interest payments, while futures only require a good faith deposit as collateral.
Duration – In the spot market, traders can choose how long they want to maintain a leveraged coin, while futures are contracts with a set expiry date that determines the duration of a position.
Targeted Investors – Both margin trading and futures aim to attract different types of traders. Margin trading is more suitable for short-term investors, while futures are more focused on long-term investors.
Understanding The Risks Of Futures Trading
Futures trading has long been attractive to traders for its potential returns. However, investors must exercise caution and weigh all the associated risks before jumping into this type of investment.
One major risk associated with futures trading is the elevated leverage that investors can take on with their already speculative positions. Typically, futures are allowed much greater leverage than their underlying assets, which can lead to an increased risk of a margin call and potentially catastrophic losses.
In addition to this, the extreme volatility of the cryptocurrency market means that the price of a futures contract may not be favorable to the investor when it comes to the expiry date.
Given these risks, beginners with limited knowledge of markets and strategies must acquire some trading skills before venturing into either margin or futures trading. Both margin and futures trading is speculative and carry substantial risks and should only be attempted by experienced traders.
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