Written by
Ewelina Skorupka
Published on
The common way of making money in the crypto market is to buy a token, hold it, wait for it to gain value, and then sell. In other words, if the coin you bought depreciates while waiting, you will lose money. However, crypto trading is now more than simple buy-and-hold strategies. Crypto futures trading is now popular. It enables traders to speculate on price movements without owning the asset directly.
With the right knowledge as a beginner, you can understand what is expected of you to make money with this trading strategy. In this guide, we will break down everything you need to know about crypto futures. This includes how they differ from spot trading, the mechanics of leverage, how liquidation works, and the distinction between hedging and speculation.
Understanding Crypto Futures
Crypto futures are standardized contracts that allow you to speculate on the future price of a coin. Hence, when you trade a futures contract, you are not actually buying or selling BTC, DOGE, or any other crypto. Instead, you are agreeing to buy or sell that asset at a later date for a predetermined price. This concept, although new to many crypto investors, has been a part of traditional finance for decades.
What makes futures attractive is the ability to profit regardless of market direction. If you believe Bitcoin’s price will rise, you can go long. If you expect a decline, you can short it. Either way, you are trading, not based on ownership, but on price movement.
A Brief History of Crypto Futures
Futures contracts in crypto have only existed since 2017, but they have become the primary strategy for many traders. The Chicago Board Options Exchange launched the first BTC futures in December 2017, although it discontinued the product a year later.
Shortly after, the Chicago Mercantile Exchange introduced its own BTC futures, later adding ETH contracts. These instruments, settled in cash, became popular among institutional traders.
Today, crypto exchanges are providing services like perpetual contracts, margin contracts, and a variety of leverage options. The ability to trade both spot and leveraged derivatives on exchanges is now normal.
Spot Trading and Futures Trading
It is essential that you understand the difference between spot and futures trading.
Imagine you go to a market to buy a pair of shoes, and you pay $45 and take them home immediately. This should give you an idea of how spot trading works, because it is instant and short term.
On the other hand, imagine you meet the seller, and both of you agree you will come and buy the shoes for $45 next week.
By next week, you will be expected to pay $45 even if the price of that shoe increases to $50. The reason is that it was the agreed-upon amount. The same would apply if the price decreased to $40.
For spot trading, the only time you make a profit is when the token’s price increases and you sell immediately. Futures, on the other hand, are derivative instruments, and you never actually hold the underlying asset. As a result, each of them works differently.
First, spot trading requires you to have full capital up front. If you want to buy 3 ETH, you need to have the money for that amount of Ethereum with you. However, futures trading introduces leverage, allowing you to control larger positions with a smaller amount of capital.
Furthermore, spot traders can’t profit from a market decline unless they sell their assets, but futures allow short selling. This feature allows you to bet against the market and make money. Finally, futures introduce concepts like margin, funding rates, and liquidation risk, which don’t exist in spot trading. For many people, terms and features like this make futures more complex.
A spot trading interface on Kanga Exchange
Leverage in Futures Trading
When you start trading crypto futures, one of the most common words is leverage. This feature allows you to increase your position by borrowing capital from the crypto exchange. For example, with 10x leverage, you can increase your $100 position to $1,000 by getting additional money from Kanga Exchange. This means even small price movements can lead to more gains or losses.
To open a futures trade with leverage, you must first deposit collateral into your account. This deposit, known as margin, is a percentage of the total position size. The higher the leverage, the smaller the required margin. However, this increases your risk because a 1% market move against a 100x leveraged position can wipe out your margin entirely. If something like this happens, it often leads to a forced liquidation.
If you want to trade futures, you must always maintain a sufficient margin level. Assuming your trade begins to lose money and your margin drops below the required level, the exchange usually initiates automatic liquidation. This process closes your position but may also result in liquidation fees and the loss of your entire margin.
What Happens During Liquidation?
Liquidation is very common in this type of crypto trading strategy. Every day, hundreds of people have their trading positions closed due to liquidation. It happens when your margin balance is no longer enough to keep a trade position open. At this point, the exchange shuts down the trade to prevent further losses. Taking actions like this protects the trader and the exchange from more losses.
This can happen very quickly in volatile markets, and it varies depending on the crypto you are trading. For example, liquidation with a meme coin like SHIB is faster than a solid asset like BTC.
To avoid liquidation, you must take steps like monitoring your positions and using stop-loss orders. Also, ensure to maintain your collateral above the minimum required margin.
Hedging and Speculation
Hedging and speculation are two different things in futures trading. One of them is trying to avoid risk, while the other is fully embracing it.
Futures contracts are used for hedging, as it is the process of opening a position opposite to an existing investment to reduce the risk of extreme price movements. Due to its functionality, it is particularly useful for investors holding multiple crypto investments.
For example, Aleksander earns a lot of money through Bitcoin mining. But he is worried that the BTC price might decrease due to economic tensions. He can protect his assets and revenue from Bitcoin mining by shorting Bitcoin futures. Assuming Bitcoin’s price drops, the gains from the short futures contract will reduce the loss in the mined coins’ value.
Image from m.Stock
Between the two terms, speculators are those who love taking massive risks. This is when you take calculated risks based on your market predictions. If you think Bitcoin is still undervalued and will increase within a specific period, you might go long on a futures contract. If you believe a crash is coming, you could short it.
People who speculate use fundamental and technical indicators to make their decisions. It is very different because, unlike hedging, speculation is about maximizing returns. These traders speculate even if that means risking their money.
Nevertheless, the dual use of futures, both as a protective and a profit-seeking tool, is what makes it unique.
Final Thoughts
It is true that futures are quite complex. You will need to learn new things like leverage, liquidation, hedging, and speculation. However, it is one of the ways to make a large amount of money in the crypto market. By understanding the key concepts, you might make a lot of money trading futures contracts.
Whether you are hedging your exposure or speculating on price moves, crypto futures require knowledge. You will need to be educated, disciplined, and manage your risks effectively.