What’s the real difference between trading spot and futures?
5 differences worth knowing that explain why Bitcoin futures are gaining popularity
Both spot market margin trading and leveraged future contracts give speculators the ability to bet on more money than they have in their exchange account.
If you buy 1 Bitcoin worth $10,000 by putting up 0.2 BTC and choosing 5X leverage, in both spot and futures if the price of Bitcoin shortly goes up to $10,100, hooray, you can cash out at around a $500 profit. If instead subsequently Bitcoin crashes close enough to $8,000, your 0.2 BTC are gone forever.
So what’s the difference?
1) Synthetic VS real
Spot markets are by definition dealing with trading a real asset, while futures are by definition a Derivative, a synthetic commitment between two sides. If you hold a normal futures contract to its end you’ll many times need to either buy or sell the real underlying asset, while some contracts are settled in cash according to the price of the asset at the due date of the contract. Meanwhile Perpetual Swaps, a popular offering in cryptocurrency exchanges, is a derivatives similar to a futures contract except that it never expires, simulating a spot holding. The usefulness of a Futures contract that is never settled or expires will be made more clear by the end of this post.
2) Spot lending fees
According to the rules of a spot market, if you want to use leverage you need to borrow real coins and pay a fee — usually a daily interest rate that is fixed for up to 20 days. These fees, of course, affect the outcome of the trade. In contrast, in the futures and perpetuals markets, funds used for leverage is accredited to your account “out of thin air” and does not carry an interest rate (though the price of the future may be slightly higher than the spot price, due to the implied interest rate in the market).
The higher the demand for leverage in a spot market, the higher the interest rate on borrowing funds. In futures markets, higher demand for leverage will only affect the price of the contract itself. Often but no always these conditions makes leverage cheaper for future and perpetuals traders.
3) Higher leverage
Spot markets have a limited supply of coins in their lending pools so they offer lower levels of leverage. A spot market has a choice of either lending 20 people funds to achieve 5X leverage or lending 1 person funds to achieve 100X leverage; that’s why they choose the former. Futures and perpetuals markets are not limited by a pool of lenders, which allows exchanges to offer leverage levels of 100X or even more to masses of users. The only job of a futures exchange is to make sure there is a balance between the buyer and the sellers, without a much winder limit to the amount of capital that is speculated on.
4) Fork ownership
In a spot market you have direct ownership of the coins you deposited and have the right to major forks (or dividends in the case of stocks) while your asset is in the exchange. Ownership of a futures contract does not reward you with any benefit of this type.
5) Trading fees
Spot cryptocurrency exchanges typically charge basic users a fee of between 0.1% to 0.2% of the position for each trade. Futures trading fees are typically 50% to 80% cheaper. While there’s a difference on paper, futures traders usually use higher leverage that creates bigger positions, thus as a whole ending up paying a similar amount of fees.
In conclusion: Futures and perpetual markets offer higher leverage for cheap by creating an artificial balance between buyer and sellers, while a spot markets consist of trading of a real assets according to supply and demand.
High leverage is extremely risky. Leveraged trading without proper and extensive training and experience is hazardous because it is a high risk zero sum game played against seasoned professionals. Similar to a beginner joining a professional poker game, the odds are not good. If you would like to study trading, I’ve found this website to have a good course.
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This post was written for informational purposes only. Be long term smart and hodl.