With the increased popularity and wide-reaching media coverage of cryptocurrencies such as Bitcoin and Ethereum, we are now seeing a rise in the number of investors and traders visiting crypto exchanges such as Coinbase or Binance. Spot trading attracts those who are risk-averse to invest in digital assets and hold on to them for extended time periods, whereas futures trading appeals to those traders who wish to further capitalize on the volatility of the crypto market.
What is futures trading?
Crypto futures trading refers to the method of speculating on cryptocurrency prices without having to actually own or handle them. Like commodity or stock futures, crypto futures enable traders to bet on a digital currency’s future price.
Futures are a type of derivative trading product – a contract. In essence, crypto futures are an agreement between two parties to buy or sell an asset on a predetermined date at a predetermined price. Traders can go long, betting on a price increase, or go short, anticipating a drop. On the contract’s expiry date, parties settle and the contract is closed.
To increase the potential gains a trader can make on their futures bet, exchanges allow traders to borrow capital to increase their trading size. Leverage rates can vary greatly between platforms. A leverage of around 2x or 5x would be regarded as appropriate for those new to futures trading.
Crypto futures pricing
Futures contracts are meant to closely track the cryptocurrency prices of the underlying assets, however, values can sometimes change through its maturity (as it reaches its settlement date). This is often down to a spike in volatility, arising from a fundamental catalyst such as a major country banning crypto.
Other changes in cryptocurrency prices include ‘gaps’. These are chunks of time where no trading takes place, so there’s no pricing data available. These gaps are only present from trading platforms like CME as they are beholden to specific trading hours, unlike the wider crypto market that trades 24/7.
Why invest in crypto futures?
Futures trading offers the potential to grow your crypto portfolio. In a nutshell, the leverage available in crypto futures can enhance a portfolio tenfold in a single trade. Crypto futures can also serve as a hedge for your portfolio when investments are trending in an unwanted direction.
As opposed to spot trading, which can benefit traders when the price is veering upwards on the cryptocurrency list, crypto futures traders can profit when the price is falling by shorting the market. Investors have more fluidity and freedom to speculate on what the price action of an asset may be, closer to the end of the futures contract.
Perpetual swap contracts
Perpetual swaps or ‘perps’ as they are known, operate in a similar way to futures contracts as they both allow investors to buy or sell an underlying asset at a future date. However, perps contracts have no expiry date. A trader can keep their contract open as long as they wish, until they’re ready to settle.
A special mechanism known as ‘perpetual swap funding rate’ is used to ensure the contract price tracks the current market price as closely as possible. Basically, long (buyers) or short (sellers) traders pay the opposite party a periodic fee, dependent on whether the contract’s price is above or below market price.
Benefits of futures trading
Crypto futures trading has become extremely popular. Here are some key advantages:
- Convenience: futures trading is great for beginners and even easier than trading actual crypto. Trading volumes in crypto futures are 2-3x more than spot trading.
- Profits: trading crypto futures with leverage offers higher potential profits. On some exchanges, you can set leverage up to 100x, meaning you can trade at $10,000 with only $100 capital.
- No funding rate: crypto futures do not have a funding rate, whereas perps do, meaning futures prices are higher than current spot prices.
Risks of futures trading
Significant risks for crypto futures trading are:
- Leverage: some exchanges may offer higher than recommended leverage, which will attract newbies. An appropriate leverage rate for beginners is around 2x to 5x, not 100x.
- Market volatility: cryptos are prone to wild fluctuations in price, which may stem from ‘whales’ or outside events, e.g. political or media.
- Poor trading strategy: using a poor futures trading plan adopted from traditional markets, with no adjustments.
Some experts believe that the crypto market is not mature enough for futures trading to exist and concerns are raised that the instability of crypto could cause a knock-on effect to other parts of the futures market.