If you’re a trader looking to navigate the world of crypto investments, you’ll likely come across the strategies of futures and margin trading. These well-known trading techniques let you gain from market shifts without owning the underlying asset.
Futures trading entails agreements to buy or sell a cryptocurrency at a predetermined price on a specified date. In contrast, margin trading allows you to borrow funds from an exchange to purchase an asset outright, expecting to repay the loan plus interest.
Even though both methods employ leverage, they have unique mechanisms, asset types, and associated risks. It is, hence, essential for you to understand the difference between margin vs futures trading to make informed investment decisions.
Futures Trading In Crypto
Let’s understand the concept of futures trading in crypto in detail.
Definition
Futures trading in crypto is a way of speculating on the price of cryptocurrencies without actually owning them. It allows you to open long or short positions on various digital assets and benefit from their price movements.
How Does Futures Trading Work?
When a trader enters into a cryptocurrency futures contract, they are making a bet on the future price of the token. If the trader believes that the cost of the crypto will increase, they can buy a futures contract. If the trader believes the price will decrease, they can sell a futures contract.
On the settlement date, the two parties involved in the contract will exchange the crypto token at the predetermined price. The contract buyer will profit if the market price exceeds the predetermined price. If the crypto’s market price is lower than the predetermined price, the seller of the contract will profit.
Features And Characteristics
Futures trading in crypto has the below-given features:
- High leverage: Crypto futures trading allows you to control a more prominent position with less capital. This is known as leverage. For example, you could use ₹1,000 to control a ₹10,000 futures contract, which can magnify profits and losses.
- Perpetual contracts: Most crypto futures contracts are perpetual, meaning they do not have an expiry date. It allows you to hold positions for as long as you like.
- Short selling: Crypto futures allow you to profit from falling prices, known as short selling. Short sellers agree to sell an asset at a specific price in the future, hoping to repurchase it at a lower price before the contract is settled. However, it is important to note here that short selling may not be legally available in your country. Hence, always check the legality before using this method.
Benefits Of Futures Trading In Crypto
Futures trading in the cryptocurrency market offers several benefits, making it an attractive option for traders and investors. Here are some of the key advantages of futures trading in crypto:
- Leverage: Futures trading allows you to use leverage, which means you can control a larger position with a relatively smaller amount of capital. This can amplify potential profits, although it also comes with increased risk.
- Hedging: Futures contracts provide an effective tool for hedging against price fluctuations. You can use futures to protect your portfolios from adverse price movements, reducing potential losses.
- Speculation: Futures markets allow you to profit from rising and falling cryptocurrency prices. This flexibility is particularly valuable in the highly volatile crypto market, where prices can swing dramatically in either direction.
- Liquidity: Crypto futures markets are more liquid than the spot markets. It means you can enter and exit positions more quickly, and price spreads are typically narrower, reducing trading costs.
Drawbacks Of Futures Trading In Crypto
Although futures trading offers several advantages, it also has several drawbacks, such as:
- High Risk and Volatility: Cryptocurrencies are already known for their high volatility, and futures trading can amplify this risk. Using leverage in futures trading can lead to substantial losses, as price movements can be unpredictable and quick. You’ll find yourself liquidated if the market moves against your positions.
- Lack of Regulatory Oversight: Unlike traditional financial markets, the cryptocurrency futures market is still relatively unregulated. This lack of oversight can make it susceptible to market manipulation and fraudulent activities, leaving you with limited recourse in disputes.
- Complexity: Futures contracts are inherently more complex than spot trading. Understanding and managing the intricacies of futures contracts, such as margin requirements and expiration dates, can be challenging for novice traders. This complexity can lead to costly mistakes.
- Costs and Fees: Trading futures typically involves additional costs, such as funding fees, spread costs, and interest on leveraged positions. These costs can eat into potential profits, making it less appealing for you if you don’t have access to substantial capital.
Having grasped the fundamentals of crypto futures trading, it’s time to learn the concept of crypto margin trading.
Margin Trading In Crypto
Definition
Margin trading in crypto is a type of trading that allows you to borrow funds from an exchange to increase your trading position. This is done using leverage, a ratio of borrowed funds to the investor’s capital.
How Does Margin Trading Work?
To open a margin trading position, you must first deposit a margin amount into your account. This margin amount is used as collateral for the borrowed funds. You then select the leverage you want to use. The higher the leverage, the more significant the potential gains and losses.
Once the margin position opens, you can buy or sell the cryptocurrency you want to trade. You will incur a profit if the cryptocurrency’s price moves in your favour. However, you will lose money if the price moves against you.
Features And Characteristics
Margin trading in the cryptocurrency market has unique characteristics, which are as follows:
- Leverage: The critical feature of margin trading is leverage. Leverage allows you to magnify your potential gains and losses. For example, if you use 10x leverage and the price of a cryptocurrency increases by 10%, you will make a 100% profit on your capital.
- Margin ratio: The margin ratio is the margin that must be maintained in the account to keep the position open. For example, if you have a margin ratio of 50%, you must maintain a margin equal to 50% of the value of your position.
- Liquidation price: The liquidation price is the price at which the exchange will close the position if the margin ratio falls below the required level. If the position is liquidated, you will lose your margin amount.
Benefits Of Margin Trading In Crypto
Margin trading in the cryptocurrency market can provide several benefits for you, such as:
- Profit in Both Bull and Bear Markets: Margin trading enables you to take long (buying) and short (selling) positions. This means they can profit from rising and falling cryptocurrency prices, making it a versatile strategy in various market conditions.
- Diversification: You can diversify your portfolios by utilising margin trading. You can hold long positions in some assets while holding short positions in others, allowing for risk management and profit potential in different market sectors.
- Access to More Capital: Margin trading allows you to access additional capital without liquidating your holdings. This can be especially useful for those who want to take advantage of short-term trading opportunities or arbitrage.
- 24/7 Market Access: The cryptocurrency market operates 24/7, and margin trading platforms are typically available around the clock. This accessibility allows you to react to market developments anytime, including outside regular trading hours.
Drawbacks Of Margin Trading In Crypto
- Margin Calls: To maintain positions, you must keep a minimum balance in your accounts. If your account balance falls below this threshold, you may receive margin calls requiring depositing additional funds or closing positions at potentially unfavourable prices.
- Interest Costs: Borrowing funds for margin trading often involves dealing with high interest rates, which can increase over time and erode potential profits. These costs can vary depending on market conditions and the platform used.
- Limited Ownership: You don’t own the underlying cryptocurrency in margin trading. You hold leveraged positions based on contracts. This means you cannot use the cryptocurrency for purposes like spending or transferring while holding a margin position.
Comparison Between Futures Trading And Margin Trading
Now that you’ve grasped the fundamentals of both margin and futures trading, let’s begin by examining the similarities between these two trading methods:
Futures Vs Margin Trading In Crypto: Similarities
Margin and futures trading are two distinct methods in financial markets, but they share some similarities, mainly when applied to cryptocurrency trading. Here are the fundamental similarities between margin and futures trading:
Leverage:
Both margin and futures trading allows traders to use leverage to control more prominent positions with less capital. This amplifies potential profits and losses, making it a high-risk, high-reward strategy.
Long And Short Positions:
Both trading methods enable traders to take long positions (betting on price increases) and short positions (betting on price decreases), providing opportunities to profit in both bull and bear markets.
Derivative Products:
In margin and futures trading, traders deal with derivative financial instruments rather than actual assets. In margin trading, traders typically borrow funds to trade spot assets, while in futures trading, they are trading contracts that derive their value from an underlying asset.
Risk Management:
In both approaches, traders must implement risk management strategies, such as setting stop-loss orders, to limit potential losses. Proper risk management is crucial to mitigate the inherent risks of leverage.
Liquidity:
Both margin and futures trading can enhance liquidity in the market by facilitating larger trading volumes. This can lead to more efficient price discovery and reduced spreads.
Margin Vs Futures Trading In Crypto: Differences
Here are the key differences between margin and futures trading in the context of cryptocurrencies:
Contract Type:
Margin Trading: Traders borrow funds to buy or sell cryptocurrencies in spot markets. They trade on the margin, meaning they can control a more prominent position size than their account balance.
Futures Trading: Traders enter into a contract to buy or sell a specific amount of cryptocurrency at a predetermined price and date in the future. These contracts are standardised and traded on futures exchanges such as Binance, OKX, and Bitfinex.
Leverage:
Margin Trading: Leverage in margin trading is typically lower than in futures trading. It varies by exchange, but it’s often limited to 2x or 3x, although some exchanges, such as Binance and Huobi Global, offer 10x and 20x leverages, respectively.
Futures Trading: Futures contracts often allow for higher leverage, which means traders can control larger positions relative to their capital. Leverage can increase to 100x or 125x on some cryptocurrency exchanges, such as Binance and Huobi Global, but higher leverage entails higher risk.
Expiration:
Margin Trading: Margin positions don’t have a fixed expiration date. Traders can hold their positions indefinitely as long as they can cover the interest on the borrowed funds.
Futures Trading: Futures contracts have set expiration dates. At expiration, the contract settles, and traders either take delivery of the cryptocurrency (for physical-settled futures) or settle the difference in price in cash (for cash-settled futures).
Funding Costs:
Margin Trading: Traders in margin positions may incur funding costs, which include interest on borrowed funds. These costs can eat into profits if the trade is held for an extended period.
Futures Trading: Futures contracts may also have funding costs, but the market determines these costs and can result in traders receiving or paying funding fees depending on their position.
Regulation:
Margin Trading: Regulations for margin trading vary by jurisdiction, and some regions may have stricter rules or restrictions on margin trading.
Futures Trading: Futures markets are often subject to more comprehensive regulatory frameworks, as they involve standardised contracts traded on exchanges. This can provide a degree of investor protection.
Factors To Consider When Choosing Futures Vs Margin Trading
When choosing between margin trading vs futures trading in the cryptocurrency market, there are several factors to consider to make an informed decision, such as:
1. Risk Tolerance
Margin and futures trading are both high-risk trading strategies. Margin trading carries the risk of liquidation if the market moves against you, while futures trading risks losing your entire margin deposit if the market moves against you.
Before choosing either strategy, assessing your risk tolerance and only using these strategies if you are comfortable with the potential losses is essential.
2. Trading Goals
Margin and futures trading can be used for various trading goals. It can increase your position size and magnify your profits.
Alternatively, futures trading can be used to hedge your portfolio or speculate on the future price of an asset. Consider your trading goals when choosing between margin and futures trading.
3. Trading Experience
Margin and futures trading are both complex trading strategies. If you are a beginner, it is crucial to start with a small amount of capital and to use a trading platform that offers risk management tools. As you gain experience, you can gradually increase your position size and leverage.
4. Time Horizon
Consider your trading time horizon. If you’re looking for short-term trading opportunities, futures trading with its fixed expiration dates might be a better fit. If you prefer a longer-term approach, margin trading allows you to hold positions for as long as you can cover funding costs.
5. Asset Availability
Not all assets are available for margin or futures trading. Before choosing a trading strategy, ensuring the asset you want to trade is available is crucial.
6. Fees
Margin and futures trading typically have higher fees than spot trading. Before choosing a trading strategy, comparing the fees charged by different exchanges is important.
Conclusion
Crypto futures and margin trading offer unique opportunities and challenges. Your choice ultimately depends on your risk tolerance, trading strategy, and financial goals. Futures trading can provide a structured way to speculate on the future price of cryptocurrencies, while margin trading offers flexibility and can amplify your gains (or losses).
However, whatever trading strategy you choose, you must remember that investing in crypto may attract taxes depending on your country. Manual calculation of these taxes can be time-consuming; therefore, you can use KoinX.
KoinX is an automated crypto tax calculating platform that provides accurate crypto tax reports based on your jurisdiction. So get registered on KoinX today and make your crypto tax easier.
Frequently Asked Questions
How Do Futures Trading And Margin Trading Differ In Risk?
Futures trading carries a defined risk, while margin trading’s risk depends on leverage, potentially amplifying losses.
Which One Offers More Liquidity, Futures Trading Or Margin Trading?
Generally, cryptocurrency futures trading tends to offer higher liquidity than margin trading.
What Is The Primary Benefit Of Margin Trading Over Futures Trading?
Margin trading provides more flexibility and allows traders to diversify their portfolios with borrowed funds.
