Why do people trade crypto futures?
Crypto futures contracts can be a powerful tool for digital asset traders looking to build a trading strategy.
Crypto futures can help protect against downside risks while executing a long term strategy. They can also be used to capitalize on temporary opportunities during short term periods of market volatility. Many use futures alongside other trade order types to maximize their earnings or minimize their losses while trading.
While futures were once an investment vehicle available only to institutional investors, they are now an accessible trading option for crypto traders as well. But understanding how and when to use these products can be a challenge for some.
If you are new to futures contracts, you can first check the Kraken Learn Center’s article What are crypto futures contracts? for more information.
For those that haven't explored crypto futures contracts, they may appear to be complex and daunting to trade. Sophisticated trading strategies often use multiple futures positions across a range of different price levels — which can be difficult for new traders to manage.
Understanding how to properly manage risk and reward with futures contracts can be a difficult skill that requires practical experience to develop.
Although constructing an effective trading strategy can be challenging, modern crypto platforms make using these financial products intuitive for traders of any skill level.
When used effectively, crypto futures contracts provide several unique advantages to traders when compared to the standard spot markets.
Reasons for trading crypto futures
A key component of crypto futures trading is leverage. Traders use margin to create leverage.
Margin refers to individuals using assets as collateral to acquire a loan for additional funds that are used in trading.
The amount the trader allocates to collateral when they first open the position is known as the initial margin. The remaining funds they hold in their margin account in order to keep their position open is referred to as maintenance margin.
Leverage is the ratio between the money invested as collateral and the amount traders have available to trade after taking the loan. Leverage allows traders to increase their “trading power” by creating larger positions with a comparatively smaller amount of funds.
Futures traders use leverage for a variety of reasons. If a trader has a high degree of conviction about a particular trade, they may want to use leverage in order to make the most of that market opportunity.
Traders that are looking to open several positions at once may also choose to use leverage. When looking to place several trades together, leverage allows traders to use a smaller amount of capital across several trades while still retaining the same trading power. Different leverage rates may apply depending on the underlying digital asset and the amount traded.
Finally, traders may choose to use leverage so that they can keep their larger crypto portfolio off of an exchange. Those that follow the saying of “not your keys, not your coins” may choose to use leverage. They do this in order to still effectively trade the same amount as their portfolio, but still keep crypto safe from attackers by following self-custody best practices.
It is important to know that just as leverage can amplify profits on winning trades, it can also extend losses on unsuccessful trades. Understanding the risks of leverage trading before purchasing futures contracts is strongly recommended.
Another unique feature of cryptocurrency futures contracts is the ability to short an underlying cryptoasset.
Shorting an asset, or "going short," allows a trader to profit when the fiat price of an underlying asset falls. This differs from spot trading, where traders can typically only profit from buying an asset at a lower price before selling it at a higher price.
A trader looking to go short will enter into a crypto futures contract agreement with a counterparty who is looking to go long on the same underlying asset. Through this agreement, the person going long agrees to purchase the underlying asset at a certain price (or exchange the cash equivalent at settlement) in the future from the seller (the person going short).
Many traders choose to use futures contracts when betting against assets they believe are overpriced in the market. Because they may feel the asset is commanding a higher price than it is truly worth, traders may not want to actually hold the underlying asset in their portfolio.
Therefore, traders may use futures contracts to avoid having direct exposure to an asset they feel is overvalued, while still being able to profit if their assumption is correct.
Crypto futures contracts are a type of derivative product, meaning they derive their value from an underlying asset.
Through various arbitrage mechanisms, futures contracts closely track, but don’t always precisely follow the price of assets like Bitcoin (BTC), Solana (SOL), or Cardano (ADA). The fact that crypto futures contracts only follow an asset’s price means traders are not required to buy, sell, or take custody of these assets.
This feature enables traders to gain exposure to crypto price volatility, without needing to move assets between cryptocurrency exchanges, create crypto software wallets, or otherwise worry about keeping their assets secure.
Many feel this exposure to cryptocurrencies without the need to custody is a win-win — particularly for institutional investors who struggle with custodying crypto but are still looking to gain exposure to the space.
Because of their indirect exposure, futures contracts may be taxed or regulated in a different way than spot trading, which may offer advantages for certain traders.
As a result, futures have opened up the crypto market to these larger financial firms. Individuals looking to access cryptocurrencies and their price movements through derivative investment vehicles may choose to trade crypto futures instead of trading crypto on the spot market.
Many attribute the rising participation of institutional investors in the crypto space to the high liquidity of crypto futures markets. Liquidity generally refers to the health of a market and how many active buyers and sellers there are within it.
High liquidity implies a healthy market with lots of buying and selling activity. This makes it easier to complete trades of any size, at any time, in a more cost-efficient way. It also reduces the chances of drastic price changes and mitigates the amount of slippage incurred. In markets with poor liquidity, the opposite can be said.
For the average trader, highly liquid futures markets mean they are much more likely to find counterparties to trade against across a range of settlement dates.
Higher liquidity also makes it easier for traders to exit their futures positions before they reach the settlement date. This makes it more cost-efficient for futures traders with open positions to sell their positions on to new market participants that may be interested in taking on their initial trades.
Hedging is a trading strategy employed by traders looking to mitigate their risks of loss if prices move against their thesis. Effective hedging is often the biggest difference between a winning or losing trading strategy in the long run.
To learn more, check out our Kraken Learn Center article What is hedging?
Hedging involves opening trades in the opposite direction of existing trades such that hedge position profits will offset the losses of the primary trade.
Traders use futures contracts to hedge their positions when they're concerned markets might move aggressively in the opposite direction to their thesis. A trader may choose to hedge their position when there's indecision in the market or when they feel less clear on which direction prices might go.
Because crypto futures allow traders to go short, it's possible to cover long spot positions by opening a short futures trade. Doing so may mean that a trader stands to make either position profit or portfolio profit, regardless of which direction the market moves.
In some cases, a trader might only break-even once the profits and losses from both opposing trades are calculated. However, thanks to leverage and increased capital efficiency from trading crypto futures, they can also stand to make an overall profit from hedging their long positions.
Compared to spot market trading fees, futures contracts typically offer lower fees compared to similarly sized spot market positions.
For traders placing a large number of trade orders across multiple price levels, they may find futures contracts to be a more cost-efficient strategy.
Advantages of futures contracts
Some of these key differences futures and spot trading include:
- Greater capital efficiency
- Ability to profit from declining prices (shorting)
- Indirect exposure to crypto market
- High liquidity
- Lower fees
Let's dive into each of these topics in more detail.
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