The cryptocurrency market offers users numerous opportunities or entry points, and futures trading is among the most popular. To trade futures, one needs to understand the intricacies as it is a tad technical; however, it is worth noting that it offers better opportunities compared to options and spot trading.
Statistics show that young investors predominantly occupy the crypto futures trading space due to their potential to earn a huge return on investment using the leverage tool. However, while this may offer huge returns, it also comes with a great deal of risk; hence, you might want to be wary about leveraging.
What Is Futures Trading?
Futures trading fall into a category of trading instruments referred to as derivatives. It allows traders to predict the prices of assets without owning them. Similar to stocks and commodity futures, crypto futures trading allows investors to predict the future price of a digital asset, with Bitcoin being the most widely traded futures asset.
A futures contract is an agreement between two traders to either take, buy or sell positions on an asset at a prescheduled time and date. This contract follows a principal asset, which could be a cryptocurrency, stock, or commodity. Unlike spot trading, crypto futures only operate with the price action of their underlying assets.
How Does Crypto Futures Trading Work?
Taking a broad look at crypto futures trading, it appears to be similar to spot trading. This is because most traders follow the same processes in both markets: opening buy or sell trades and applying proper risk management techniques.
Crypto futures function as hedging instruments for fluctuations in the regular market. Traders can leverage these price movements rather than buying or selling the main digital asset. That said, the futures market has two major participants; the speculators and the hedgers.
The speculators are the independent floor investors and traders. This category of people, popularly called locals in the trading space, handle their personal accounts and that of clients and brokerage firms. Speculators basically have one major goal: to make a profit from price changes in the futures contracts. They just bet on the market based on price movements.
On the other hand, hedgers are individuals or businesses who deal with the actual crypto asset. Their role is to support the momentum of a crypto asset while also securing the price and limiting the possibility of volatile swings. Hedgers trade the actual cryptocurrencies because their businesses depend on them. But they also use futures to reduce their exposure to risks during extreme market volatility.
Using an applicable example to explain the intricacies of crypto futures, let’s assume a trader wants to predict the price of Solana by the end of 2021. Solana is currently trading at $238.37, and if he believes that the price will increase by the end of the year, he can lock in a buy contract.
Depending on the leverage size he chooses, he can increase the worth of his transaction while paying only a fraction of the entire trade. This fraction is known as the initial margin and is deposited with the broker. It is worth noting that leveraged trading also presents a high risk of capital loss; therefore, traders should apply proper risk management while using it. Every trade will remain valid if the losing margin doesn’t go below the trader’s initial deposit.
In a scenario whereby the margin cannot accommodate the loss, the broker will automatically liquidate the contract, an act known as a margin call. The trader may, however, decide to deposit more funds to maintain his futures contract. Thus, he could make profits or losses depending on the market’s direction by the end of the contract duration.
Futures contracts usually have an expiration date, but there is a different category in the crypto space called perpetual futures. These types of contracts do not expire and can only be closed by the trader or when the price reaches the take profit or stop loss point. In addition, perpetual futures have similar prices with spot instruments. This market is primarily driven by the funding rate as buyers and sellers pay each other regularly, depending on price direction.
The Potential Impact of Crypto Futures Trading On the Global Market
Crypto futures trading offers numerous benefits to the global financial markets, including inflation control and seamless transactions. They also allow traders to diversify their portfolios and hedge against potential risks. In essence, the futures market offers similar advantages as precious metals like silver and gold, which is among the reasons why it is flourishing.
However, analysts suggest that a crypto market crash could have a negative effect on the global market, similar to that of 2008 global financial crisis. The total market capitalization value of digital assets stands at $1.9 trillion, which is larger than popular companies like Microsoft Corporation, Meta, and Amazon. Nonetheless, using cryptocurrencies – and by extension crypto futures – as asset classes is dynamic and can tip in any direction.
What Are The Potential Pitfalls Of Crypto Futures?
As more crypto investors continue to join the futures bandwagon to expand their portfolios, they must understand that futures trading has pitfalls. Many of these pitfalls are caused by market factors and price movements, whereas trading platforms create the others.
The underlying assets of futures instruments are extremely volatile, and there is no way to curb it. As a result, many regulated exchanges place an automatic 5-minute trading halt for a 20% price spike and a 2-minute halt for a 10% spike to ‘calm the market.’
These conditions are far from normal and are detrimental to newbie and sometimes veteran traders as they may miss some profitable trading opportunities within that duration. Also, trading futures isn’t cheap as some exchange platforms have a margin requirement of up to 40%. If the market exhibits volatile price swings, an undercapitalized investor may have trouble maintaining his trades.
Today, some retail and institutional traders prefer to trade crypto futures due to the market’s profit potential and convenience. By and large, it has become more popular than both the spot and options markets in the crypto space.
However, it is worth noting that while they allow traders to hedge against volatility risks, leveraged trading is a high-risk investment. Therefore, traders should do well to protect their funds using proper risk management techniques.