Crypto margin trading and futures are similar to traditional margin and futures trading. Both futures and margin trading are sophisticated trading strategies that require the investor to have strong trading skills. They are two distinct investment types that pursue the same objective but do so in various manners.
Borrowed money is used in margin trading to buy and sell cryptocurrency. Furthermore, traders engaged in futures trading can use margins as collateral to open important long and short positions on contracts with fixed delivery dates.
Imagine that you have the money to purchase 50 shares of a growing company but would like to purchase 100. By negotiating the collateral and degree of leverage for your position with your brokerage company, such as Coinbase, you can borrow the money necessary to purchase the additional 50 shares “on margin.” Margin trading allows you to increase your returns on investment and explore transactions that you might not otherwise be able to.
Futures trading, or simply “futures,” is the term used to describe trading with futures contracts, a type of derivatives contract in which you commit to purchase or sell an asset at a certain price and date. Consider that you are an oil distributor trying to lock in prices to guard against a future price swing. You can open a futures brokerage account and a futures exchange account. You can then create a contract with a customer who, barring any unforeseen events, will buy your items on the specified date.
In the next part, let’s examine whether they are comparable or different.
Margin Trading: Meaning
Margin trading is a practice that enables investors to purchase more assets without using their own money and instead borrow money from a broker. It is betting on the cryptocurrency market with “leverage,” or borrowed money, while only exposing a portion of your cash. The margin is the amount of cryptocurrency needed for a leveraged position.
There are two methods to start a margin trading position:
- Taking a short position is betting that the price will fall.
- A long position is one in which you wager that the price will increase.
In a long position, you buy crypto intending to later sell it for more money and profit from the price difference. In a short position, you take out a loan against crypto at its current price to buy it back at a lower price to make more money.
An investor must receive permission from the service provider to open a margin account to deposit cryptocurrency, cash, or securities as security for the loan to trade cryptocurrency on the margin. Leverage will magnify wins and losses when trading cryptocurrencies on margin. A margin call could happen when there are significant losses, like a decline in the equity value of the securities.
A margin call gives the exchange or a broker the option of forcibly liquidating the investor’s collateral to satisfy the broker without the investor’s permission or asking for more money to be deposited into their margin account.
Futures Trading: Meaning
Futures contracts are a type of derivative trading instrument. These are regulated trading agreements where two parties agree to buy or sell an underlying asset at a specified price on a particular date.
Investors can safeguard themselves from volatile market conditions and ensure that they can buy or sell a particular cryptocurrency at a specific price in the future via futures. The trader may, however, purchase Cryptos for more than the market price or sell them at a loss if the price changes against their wishes.
Instead of dealing with the hassle of actually buying or selling cryptocurrency through private keys, passwords, and other means, some crypto enthusiasts choose to invest through futures trading. Simultaneously, they have gained exposure to the asset.
Futures contracts are characterized by their expiration month. They are exchanged on futures exchanges such as the CME Group, the largest and most well-known in the world. The Futures Industry Association (FIA) estimates that in 2021, 29 billion futures contracts were traded. With more people interested in this kind of investment, the market for futures trading in cryptocurrencies is expanding.
According to CME, the added daily value (ADV) of contracts and Micro Bitcoin futures trading in 2021 increased by 13%. The advantages of futures trading primarily allow investors to hedge the price movement of a crypto asset to help prevent losses from adverse price swings.
To reduce their risk exposure and protect themselves from price changes, investors who hedge adopt a position opposite to the one they hold with the underlying asset. If they lose money on the latter, the hedged position will help them to recover their losses.
Trading futures carries a risk of financial loss. However, losses are reduced and can be less severe than with margin trading due to the hedging component. Similar to margin accounts, opening a brokerage account to trade cryptocurrency with futures needs getting permission from the exchange or the broker.
Understanding the Mechanics of Margin Trading
Margin trading attempts to accelerate gains and allows seasoned investors to do so immediately. If the trader is unfamiliar with how they operate, they could also result in significant losses.
Investors in cryptocurrencies borrow money to trade on margin from a brokerage house. They first make a cash deposit into a margin account, which serves as a security deposit and collateral for the loan.
Then, depending on the state of the market, they begin paying interest on the borrowed funds, which may be paid in full after the loan or in weekly or monthly installments. The asset sales revenues are utilized to pay off the margin loan first.
The loan is required to increase investors’ purchasing power and enable them to make larger purchases of crypto assets. As a result, the assets acquired serve as collateral for the margin loan.
The amount an investor can borrow is determined by the cost of the asset acquired and the value of the collateral.
Understanding the Mechanics of Futures Trading
Investors can wager on the price of Bitcoin through futures trading on the cryptocurrency market. For example, at a specified date in the future, all without owning any of it. Trading cryptocurrency futures involves a formal agreement between a seller who wants to set a price in hopes of profiting at a later date and a buyer who will buy the contract to avoid paying higher prices in case the asset’s value increases.
Futures exchanges are responsible for ensuring contract fulfillment at the contract’s expiration date, regardless of the asset’s actual price at that time. Futures are frequently quarterly or permanent contracts in cryptocurrency trading.
The following must be included in futures contracts:
- A futures contract’s expiration date: when settlement is completed under the stated conditions;
- The value of the contract: the quantity of bitcoin used as the contract’s underlying asset;
- Leverage: On some exchanges, traders may borrow money to expand the size of their positions and raise their chances of profiting;
- The settlement method might typically be a bank transfer, a cryptocurrency, or cash in hand.
Futures trading and margin trading are both financial instruments. They want to make it possible for investors to purchase additional cryptocurrency using their equity. They both function as speculative instruments and take various routes to the same end.
Both of them have the potential to produce greatly increased returns but also greatly increased losses. It’s surprisingly simple to make sizable, quick gains, especially in the unpredictable cryptocurrency market. It is advised that only seasoned traders utilize these tools as significant losses can also happen.
- Different markets
Margin trading and futures differ primarily in the market in which they are executed. Margin contracts are traded on the spot market, while futures are traded on the derivatives market.
When trading cryptocurrency on margin, the typical leverage runs from 5 to 20%. However, when trading futures, the typical leverage often exceeds 100%.
- Collateral allocation
Futures require a good faith deposit as security. Traders can leverage spot market prices through cryptocurrency margin accounts, which require them to pay interest on the loans.
The spot market is permanent; thus, traders must decide how long they want to leverage a coin. Contrarily, futures are contracts with an expiration date that establishes the time you may keep a position.
To execute margin trading and futures, they target two different sorts of traders. Futures trading is more relevant to long-term investors than margin trading is to short-term investors.
|Margin Trading||Future Trading|
|Collateral allocation||Loan with interest||Good faith deposit|
|Duration||Up to the trader||Have an expiration date|
|Types of investors||Short-term||Long-term|
- Because of the leverage component, crypto margin trading is riskier than regular trading. It may result in the investor losing more money than they initially had.
- Given the extreme volatility and unpredictability of cryptocurrencies, the investor may need to contribute additional monies to the collateral to avoid being compelled to sell.
- Investors begin paying interest on the loan they took out to margin trade on the first day, and the debt grows as the interest accumulates.
Always remember leverage trading is EXTREMELY dangerous. True story: I walked into a glass wall at the airport while I was watching my trade. Please be aware of your surroundings if you are going to trade.
— Ben Armstrong (@Bitboy_Crypto) January 18, 2023
- The biggest risk in futures trading is the heightened leverage investors can request with their already speculative positions.
- Futures frequently have access to far higher leverage levels than the underlying assets, which increases the danger of a margin call that might prolong losses.
- The price of a futures contract may not be in the investor’s favor at the expiration date due to the tremendous volatility of the cryptocurrency market.
Margin account users sometimes borrow money to begin their crypto investments. Your portfolio gives you more capital control, as a result, allowing you to use leverage to take on more risk. Trading on margin entails greater risk than without leverage because it enhances your potential for both wins and losses.
In a futures contract, a buyer or seller commits to buy or sell an underlying asset at a future price. You can go long or short on futures, depending on your directional bet.
Before engaging in either margin or futures trading, beginners with limited market and strategy expertise should develop their trading skills because these are speculative and risky investment instruments.