Ever since the boom of the cryptocurrency market, crypto trading platforms are not just restricted to the Spot market, new hybrid markets consisting of complex derivatives products have come into existence. One such derivative product is Crypto Futures.
Typically investors get scared and confused the moment they hear terms like Derivatives and Futures but if you want to level up in the world of cryptocurrency trading, Crypto Futures trading would be the next logical step for you. Normally experienced traders trade in Crypto Futures but this article might help you better understand and get a grip on the concepts of Spot trading and Futures trading.
Let’s begin with what is Crypto Spot trading and Crypto Futures Trading before discussing the differences between the two AKA Spot Trading VS Futures Trading.
What is Spot Trading?
Financial Instruments such as currencies, securities, and commodities are traded in a Spot Market for instantaneous delivery.
In Spot Trading the payment and delivery are done immediately and it involves actual delivery of the cryptocurrency.
Every time you go on a cryptocurrency exchange and tap on the buy or sell button and the transaction is completed immediately i.e., the ownership transferred and the payment done at the moment, this type of trading is called Spot Trading.
Spot Trading is the most common type of cryptocurrency trading, investors buy cryptocurrencies at current market prices and hold them until their prices increase to make a profit by selling them at a higher price than the price it was bought at. The current market price of any asset is known as Spot Price.
In Spot Trading the Cryptocurrencies are bought at spot price and ownership is transferred to the buyer, thus enabling investors to stake them and earn interest over them or to vote on major forks.
Advantages of Spot Trading
- Due to the easy and simple execution of transactions, Crypto Spot Trading is straightforward.
- It involves only one price i.e., Spot Price (Current Market Price) which depends on the supply and demand therefore the price is transparent.
- Investors trade directly in assets and not value derived on it which allows staking and thus earning interest.
Disadvantages of Spot Trading
- Holding cryptocurrency assets that aren’t profitable can be inconvenient and there is a responsibility to keep them secure.
- Leverage fees are much higher in Spot Market hence profit earning opportunities are lower.
- Cryptocurrency assets held in exchange wallets are susceptible to hacking incurring huge losses to investors.
Before we dig deeper into Crypto Futures Trading let’s understand what are derivatives.
What are Derivatives?
A derivative is a financial contract that derives its value from the performance of an underlying asset. Underlying Assets can be assets like currencies, stocks, commodities, or financial assets. There is no actual delivery of the underlying asset in a derivative contract nor is there any need to own the underlying asset.
For example, if you buy a BTC/USD contract in the derivatives market, in this scenario you are not actually buying BTC, the value of your derivative contract will move as per the movement in the price of BTC/USD. If the price of BTC/USD drops then the value of your contract drops and vice-versa.
Derivatives contracts are usually used to reduce risk exposure or for protection against the price volatility of cryptocurrencies. Through crypto derivatives, investors can speculate on the future prices of cryptocurrencies.
Now that we’ve covered the meaning of derivatives, let’s go ahead and understand Crypto Futures Trading.
What is Crypto Futures Trading?
A futures contract is a type of Derivative contract, it derives its value from an underlying asset ie, cryptocurrency. In a Futures contract, you decide to either sell or purchase an underlying cryptocurrency at a future date at a predetermined fixed price.
You don’t own the underlying cryptocurrency on purchasing a futures contract instead you trade on speculative prices. Therefore there is no economic benefit of staking and earning interest as there is no ownership of the underlying cryptocurrency.
In a futures contract, you are betting whether the price of the cryptocurrency will increase or decrease and your profit or loss will depend on how precise your prediction is. Thus Future contracts enable investors to make money even in a bearish market. Depending on your prediction you will take a long or short position.
Short position is taken when the price of the cryptocurrency is expected to go down.
Long position is taken when the price of the cryptocurrency is expected to go up.
Advantages of Crypto Futures Trading
- Due to leveraging, gains much higher than the Spot Market can be earned.
- Profit can be made in a Bearish Market.
- Flexible strategies can be employed for risk exposure management.
- It is not limited to just buying and selling.
Disadvantages of Crypto Futures Trading
- There is a high risk involved due to the unpredictability of the crypto market as speculative investments can incur huge losses in an unstable market.
- Investors cannot enjoy the economic benefit of staking and voting as there is no ownership of the underlying cryptocurrency.
Crypto Spot trading VS Crypto Futures Trading
Leverage allows investors to gain maximum profit with the least invested amount thus making the Futures Trading Capital-Efficient, with leverage you can open 1 BTC future position with just a fraction of the market value of 1 BTC. In a spot market, there is no leverage available and to buy 1 BTC, you will have to pay the current market price which is thousands of dollars.
- Spot Price VS Future Price
All the transactions in the spot market are at the current price and settled at the same price. On the other hand, Future Prices are calculated at spot price plus futures premium. A positive future premium means the spot price will be lower than the future price and a negative future premium means the spot price will be higher than the future price.
- Counterparty Risk
In any futures transaction, there is a seller and a buyer, there’s a possibility on the date of the agreement one of the parties does not honor the contractor is unwilling to reciprocate. In the spot market, there is an upfront trade therefore there is no counterparty risk as such.
- Long or Short Flexibility
You can only benefit in the Spot Market if there is a capital appreciation in the value of the cryptocurrency held. But in a futures market, you can take long and short positions and by shorting, gains can be earned even when the price of the cryptocurrency is going down. This will also protect long-term investors from the volatility in the Crypto Market.
Make sure you do in-depth research and gain experience as a Spot Trader before entering the Derivatives Platform but don’t wait too long and miss out on opportunities to earn substantial gains from the Derivatives market.
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