Why Trade Perpetual Contracts with USDT As The Settlement Currency?
AAX will soon be offering perpetual futures contracts for a number of major crypto-to-crypto pairs, where the settlement currency is USDT, instead of Bitcoin (BTC).
If you’re not so familiar with what perpetual futures contracts are, or why this update is significant, this post may provide some insight.
Perpetual futures contracts
When you trade perpetual contracts for, say, BTCUSD, you’ll notice that the market closely (although imperfectly) follows the global spot price.
The way these two markets are made to move in unison differs across exchanges, depending on how they’ve been designed. But on AAX, our futures markets take their cues from our own indices, using the global mark price (instead of the local order book) to determine the liquidation price.
This may sound complex, but it should become clearer if you think of it in the following way:
When you trade perpetuals, you are essentially investing in your view on the market — some would say, you’re betting on what the future price will be.
As you know, the price of BTC against USD differs slightly across various exchanges (presenting opportunities for arbitrage), but if you put all these prices together and take into account volume, trade frequency, and trade size, you can calculate a weighted average to estimate the actual global spot price.
When you trade futures, you need to decide whether you think the price will go up or down. If you believe the price of BTC/USD will go up, you go long, and if you believe the price will go down, you go short. If you’re right, and you close your position at the right moment, you make a profit.
To incentivize traders to place and execute orders in such a way that price discovery in the futures markets follow the spot markets closely, exchanges often implement a funding mechanism.
On AAX, this funding takes places every 8 hours, on a rolling basis. If the price on the futures market is slightly below the spot price (meaning there is a need for more long positions, then a small amount is transferred from the ‘shorts’ to the ‘longs’, and vice versa. At the moment, this is settled in BTC.
Trading with leverage
Trading futures can be very attractive, and not just because you can make considerable profits even in a bear market (when the price drops consistently), but especially because you can trade with leverage.
On AAX, you can trade BTCUSDFP with 100x leverage. This is how it works: Say, you put in 0.1 BTC with a 100x leverage, you are essentially trading with 0.1 x 100 = 10 BTC.
Now, if you go long with this contract and you close your position after the price has risen by 2%, you will have made a 200% profit. Instead of 0.1 BTC, you now have 0.3 BTC (this does not take trading fees into account).
Of course, trading with high leverage is also risky. If you go long with 100x leverage, and the price goes down, once it’s dropped by 1% (1 x 100 =100% loss) you will be automatically liquidated — in other words, you exit the market and lose your initial margin (in this case, 0.1 BTC).
So, unless you are absolutely certain about the direction of a market, it’s usually safer to trade with lower leverage. For example, if you trade with 10x leverage, you won’t be liquidated unless the price drops by 10% ( 10 x 10 = 100%).
You can learn more about this from our Beginner’s Futures Guide.
Why is AAX introducing USDT as a settlement currency?
This is where things get a bit easier.
When you trade futures contracts where the settlement currency is BTC, whether you like it or not, you are automatically exposed to BTC.
This can sometimes lead to unwanted results.
For example, if you’re trading futures contracts for ETHUSDFP with BTC as the settlement currency, even if you make a profit and close your position resulting in an increase of BTC on your end, but in the meantime, the price of BTC/USD has dropped significantly, you may end up with a loss.
You may have increased your BTC funds, but it BTC is worth less than before, your overall portfolio may have suffered a loss in value.
Of course, there are ways to hedge against such risk — you can read about it here.
But this potential problem is not an issue, when the settlement currency is stable — hence, the shift towards USDT.
Unlike BTC, USDT is not so volatile, as it is pegged to the value of the US dollar. While there have been criticisms in the past as to the way in which Tether (the company behind USDT) has set the peg, USDT is by far still the most dominant and reliable stablecoin in the market, and as such a safe.
With USDT as the settlement currency, for both the initial margin and funding, it will be easier for traders to minimize unwanted exposures and build stability into their portfolio.
Trade with AAX
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Originally published at https://academy.aax.com on February 23, 2020.
