4.3.0. Three Basic Concepts of Crypto Futures Trading
If you desire to trade in crypto futures, you will have to familiarize yourselves with essential concepts on crypto futures. Being aware of these concepts will draw you closer to becoming a professional trader.
1. Leverage
Leverage has been the main thing that attracts crypto traders to the futures market. Because of the available leverage, futures trading is extremely capital-efficient.
For example, to buy 1 Bitcoin on the spot market, you will need thousands of dollars – 50 000 USD at the time of writing this article — depending on the current market prices. With a futures contract, you can open a Bitcoin futures position at a fraction of the cost. This is only possible if leverage is used. The more leverage you have, the less money you need to put into a position. In contrast, leverage is not available in spot trading.
2. Margins
Margin refers to the amount of money you will need to enter a futures trading and the minimum you will need to keep your futures trading running.
An Initial Margin is needed to enter into a futures position. An Initial Margin is the percentage of a futures position’s speculative value that must be covered by cash or collateral when using a futures trading account.
A Maintenance Margin refers to the minimum amount that you need to keep your trading position open. Maintenance Margin checks are continuous and help in margin utilization calculation. When a trader's Maintenance Margin limit is hit, his position gets liquidated.
3. Funding Rates
Crypto contracts don't settle like traditional futures contracts. Therefore, crypto exchanges require a system that ensures that the index prices and futures prices converge regularly. This mechanism is called the funding rate.
Funding rates are calculated based on the price difference between spot and futures markets. Investors will pay or receive funding payments relative to the open market positions.
Funding rates make the perpetual futures contract price close to the index price. All cryptocurrency derivatives exchanges use funding rates for perpetual contracts. The standard unit is a percentage.
Funding rates can have adverse effects on traders. For instance, funding rates may surge in an overheated bull market, making it costly for traders to hold long positions.