The financial market keeps growing as years pass by, with innovative instruments such as futures. Generally, futures are derivative contracts that allow traders to invest in an underlying asset based on a predetermined future price. Since traditional and crypto futures are derivative contracts, what are their differences?
The significant difference between crypto and traditional futures is the type of underlying asset. Crypto futures are mainly cryptocurrencies, while traditional futures assets could be commodities, stock indices, currencies, etc.
Other differences between traditional and crypto futures include the regulatory environment, the market hours, volatility rate, liquidity, and many others. Read this article further to discover these differences, including the leverage and risk level between the traditional and crypto futures.
What are Traditional Futures?
Traditional futures are also known as futures contracts. It simply involves buyers’ and sellers’ decisions to buy and sell a particular asset for a certain amount in the future. The idea of traditional futures is to protect traders from a high market volatility rate. Thus, the parties involved will lock the prices of a commodity via contract. The asset could also be stock or foreign currencies.
Here is a scenario that further explains how traditional futures work:
If a trader who sells wheat chooses to lock the price in preparation for a future event, they can form a contract with another willing individual. Now, the other party may be someone who would love to lock the price of wheat for fear of the asset price rising in the future. The person selling the wheat also considers that the market price may fall, causing a profit shortage. Both parties will sell for the initially agreed-upon price at the end of the agreement or after the timeframe has elapsed.
What are Crypto Futures?
Crypto futures have a similar concept to traditional futures in that the parties involved also speculate on the future price of an asset within a specific period. However, crypto futures are a newer concept than traditional futures, and the concept is based on cryptocurrencies like Ethereum and Bitcoin.
You can learn the differences between the cryptocurrency market and the stock market here.
Crypto futures majorly take place on online exchanges. This allows many crypto enthusiasts and traders to participate in futures trading. Thus, futures trading platforms like Solus Finance are striving towards the goal of converting a large number of their target audience. For example, Solus Finance, on a mission to bring GenZ into the web3 space, has recorded 100,000+ transactions on its app.
Here is a tweet emphasizing Solus Finance’s progression and popularity among its target crypto users.
🚀 WE'RE SOARING HIGH 🚀
✊🏻 Super pumped to share these stats:
⏱️ On an average, 2 users sign in to Solus every minute
🌏 SEA has the most number of Solusites
🇪🇺 Followed by The European Union
🌍 Followed by Africa!
❤️ Thanks to every Solusite!
🌐 Join the club if you haven't… pic.twitter.com/XXMFaQPHVX
— Solus (@SolusFinance) August 3, 2023Here is a step-by-step process to participate in crypto futures, using the Solus Finance trading platform as a reference:
- Visit a reliable and trustworthy trading platform. In this case, app.joinsolus.xyz.
- You can sign up with an existing crypto wallet. Solus Finance allows you to use an email address or ERC-20 wallet.
- Ensure to verify your identity via identification or a government-issued ID.
- You need also to ensure you have some deposits in your wallet.
To learn more about cryptocurrency wallets, kindly check this piece.
Kindly bear in mind that Solus Finance is at its testnet phase, so you can use the SUS Coins to refill your wallet. However, the SUS Coins are in-app currencies and will not be valid again once Solus Finance hits the mainnet.
How Investors and Traders Use Crypto Futures
Three significant ways in which investors and traders use crypto futures are:
Hedging
Crypto traders and investors can hedge against potential loss due to the volatile nature of cryptocurrencies. Thus, crypto futures allow traders or miners to sell or buy a crypto asset at a favorable price.
Speculation
Trading crypto futures also involves speculations, where traders can go short (sell) or long (buy), depending on the market price movement.
Arbitrage
Crypto arbitrage is a trading strategy that experienced traders often employ. This is when investors take advantage of the price differences in the financial market by buying at a cheaper price than the selling cost. For instance, Ethereum may cost $4,800 on Binance, while it costs $4,900 on Coinbase. The price differences are usually small, and the strategy needs to be implemented quickly because the price difference doesn’t stay long.
Here is a detailed article from DroomDroom that explains crypto arbitrage trading.
Key Differences Between Crypto and Traditional Futures
According to CoinDCX, Bitcoin futures hit a high rate of $1.3 trillion in March 2023, which is low compared to the trading volume of $2.69 trillion recorded during the bull run in May 2021. This again confirms the high volatility rate of crypto futures, especially when compared with stock or other assets owned in traditional futures. Other key differences between traditional and crypto futures are further explained below.
Underlying Assets
As mentioned at the beginning of this piece, the underlying assets that investors or traders invest in differ for crypto and traditional futures. Traditional futures give traders value for their investment through stock market indices, commodities (such as oil or gold), or currencies (such as USD or EUR). On the other hand, traders who invest in crypto futures will derive value from digital assets, such as Ethereum, Bitcoin, or Litecoin.
Market Hours and Accessibility
Unlike the crypto market, which is accessible 24/7, traditional futures markets usually set trading hours and, in most cases, are closed during weekends and holidays. This is a drawback for traditional futures traders because it hinders them from taking immediate action when an external event that could change the asset’s market price surfaces.
The Regulatory Environment
There is a standard regulatory operation in traditional futures, unlike crypto futures. Before an exchange can be used for trading, it must meet legal standards that frown on illegal or fraudulent activities.
On the other hand, the laws governing crypto futures regulations vary with jurisdiction, and they are less strict. The crypto market allows traders to participate in perpetual futures trading. This means traders can trade anytime and use a futures contract with no expiry date.
Volatility and Risk Profile
Even though traditional futures are also volatile, the prices are usually stable to a larger extent than crypto futures. This is mainly because the crypto market isn’t mature yet, and the regulatory environment isn’t strict. Thus, it increases the risk profile of the crypto market, as external factors can cause dramatic price fluctuations, which can expose investors to greater risks.
If you are wondering why the crypto market is so volatile, you may want to read this article.
The Liquidity Level
The liquidity in the crypto market is wide, which is due to sudden price fluctuations. Also, liquidity varies based on the type of cryptocurrency. For instance, less popular coins are usually less liquid than coins like Bitcoin. On the other hand, the liquidity level of traditional futures is high, as people can enter or exit positions without causing a massive impact on the market price.
Leverage and Margin Requirements
The leverage rate is higher in crypto futures than in traditional futures, which means the potential loss and gain are also higher. Also, crypto futures traders can trade in any contract size of their choice, unlike traditional futures traders with fixed contract sizes. This also implies that investors who trade in traditional futures often have a fixed margin amount, usually determined by brokerage firms. These firms or authorities will use the market condition and the risk surrounding the underlying asset to calculate the margin amount traders need to pay upfront.
Comparative Analysis of Risk Management of Crypto Futures Vs Traditional Futures
The risk management in crypto and traditional futures follow the same strategies, but they have specific differences, hence the comparative analysis.
- Risk-reward ratio: The risk-reward ratio is a vital strategy for crypto and traditional futures trading. You need to calculate if the reward from an investment is worth the risk involved. The trader’s risk tolerance level should determine this and how much capital they are willing to invest.
- Diversification: Diversifying investment portfolios is easier with traditional futures since there are various assets to invest in. It may be challenging to diversify with crypto futures because they are mainly digital assets. However, you can diversify by investing in a digital asset and any commodity you choose.
This article reveals the strategies that work when diversifying a crypto portfolio.
- Stop-loss orders: Stop-loss orders are efficient for both crypto and traditional futures. This strategy can be used to avoid potential loss or gain by choosing to sell an asset once it hits a particular price. For instance, if you set a stop-loss at a 5% reduction in the presumed market price, you would only lose 5% of your capital.
Conclusion
Hopefully, you can decide between traditional and crypto futures trading, having learned the concepts and differences. Meanwhile, you can even invest in both forms of futures trading to boost your profit potential. It’s also crucial that you conduct your research with due diligence so you can identify the best trading strategy that works best for you. You can become a guru investor within a few years with proper implementation and consistency.
