Currently, both centralized and decentralized cryptocurrency trading platforms offer a wide range of types of trading. While beginning traders are usually advised to start with spot trading as a simpler and more straightforward option, the cryptocurrency derivatives market should not be overlooked. Over the past few years, it has grown manifold.
One of the most popular derivatives among others is futures. Understanding the differences between spot and futures markets is one of the first steps to becoming an experienced crypto trader. In this article, we will explore the features of both spot and futures trading and compare them in several ways.
What is Crypto Spot Trading?
Spot trading is the purchase or sale of cryptocurrency with immediate delivery (payment “on the spot”). This type of trading allows the exchange of any assets — cryptocurrencies, NFT, fiat currencies and others.
Spot trading is the most common and simplest type of cryptocurrency trading. The essence of spot trading strategy is buying cryptocurrency at current market prices and selling it later it at a higher price.
Spot transactions take place on a wide variety of platforms, from centralized and decentralized cryptocurrency exchanges, to common Telegram chatbots/bots. All cryptocurrency spot exchanges operate 24/7, unlike traditional stock exchanges.
Advantages of Spot Trading
Spot trading has several important advantages which make it so popular:
- First, it is extremely easy, even for beginners;
- Spot market traders take ownership of the purchased assets;
- The risks are minimal due to the absence of such complicated notions as margin, leverage, expiry, and liquidation.
Disadvantages of Spot Trading
However, spot trading is also associated with some disadvantages:
- Since the trader takes the ownership of the cryptocurrency, they are burdened with its storage;
- Leverage trading is not allowed on the spot market, which reduces the opportunities for greater profits;
- For the owners of the purchased cryptocurrency, it is possible to make income only at a rising market. Thus, during the bearish trend, the investor's assets will lose their value.
The Types of Spot Market
Spot trading occurs in two different markets — OTC markets and cryptocurrency exchanges such as Redot.
Cryptocurrency exchanges are the backbone of the cryptocurrency industry. That is why, spot trades are executed mainly on cryptocurrency exchanges. Moreover, cryptocurrency exchanges also allow for generating passive income through staking assets.
Transactions on exchanges are made through a trading terminal with the order book or an automated market maker. The exchanges can be centralized (CEX) and decentralized (DEX). Centralized exchanges are in fact the organizations, which provide intermediary services between the buyer and the seller. Decentralized exchanges, on the other hand, are blockchain-based. The trades are executed directly between the seller and the buyer without intermediaries.
OTC or over-the-counter trading refers to transactions on P2P (peer-to-peer) platforms. The assets are exchanged directly between individuals or organizations. OTC trading usually takes place on aggregator sites or telegram bots, with the sufficient number of sellers and buyers.
OTC platforms offer a higher level of anonymity than centralized exchanges (though more and more platforms now require KYC). However, with many exchanges introducing an escrow mechanism, OTC trading can be considered a fairly reliable way to buy cryptocurrencies.
It is important to note that OTC markets attract not only small investors seeking to remain anonymous, but also the “whales”. The big players make purchases on the OTC market so that their large transactions do not affect cryptocurrency charts.
What are Derivatives?
Besides spot, there are other financial instruments available in the crypto market. One of them is crypto derivatives. They are essentially contracts for buying or selling an asset at a particular time in the future. Traders do not take the ownership of the underlying assets, but have a right or obligation to execute the contract.
Derivatives allow using leverage trading, which can potentially result in higher profits. However, one should keep in mind that derivatives are quite a complex instrument. They should only be used after gaining enough knowledge of this instrument. Otherwise, traders are facing higher risk of the loss of funds and incurring debt.
What is Crypto Futures Trading?
One of the most popular cryptocurrency derivatives are cryptocurrency futures. They are contracts that reflect the value of the underlying cryptocurrency. Buying a futures contract is not equal to buying its underlying asset. You become the owner of the contract with an obligation to buy or sell the underlying asset in the future at a predetermined fixed price.
For example, when you trade a BTCUSD contract, you are not actually buying or selling BTC, but rather trading at the value derived from BTC. You are betting on whether the price of the underlying asset (BTC) will increase or decrease. The profit or loss will depend on how accurate your prediction is.
Futures trading is a high risk, high profit activity, which is more suitable for experienced traders and investors. Above all, this is due to the possibility of using leverage, which allows opening much larger positions with borrowed funds. Thankfully, the risks of margin trading are to some extent covered by the mechanisms of protection and risk management, such as insurance funds.
Advantages of Crypto Futures Trading
Futures trading has a number of advantages:
First of all, in good hands, it is an excellent tool for hedging risk;
- All futures can be sold short, giving the chance to make a profit on the bear market;
- Leverage allows entering into transactions for amounts traders do not have to increase profit;
- Futures are among the assets with high liquidity, as they are quite popular among traders.
Disadvantages of Crypto Futures Trading
Among the disadvantages are high complexity for beginners to enter the futures market and high risks, especially when using leverage. Short-term fluctuations in the value of the underlying asset can lead to position liquidation and significant losses. Also, futures do not give owners privileges. Investors cannot benefit economically from staking, for instance, because they do not own the underlying cryptocurrency.
Crypto Spot VS Futures Trading
Both spot trading and futures trading are two of the most popular ways to trade cryptocurrencies. So, what's the difference between spot and futures trading?
When talking about futures vs spot, the concept of leverage is the major difference between the two. Leverage is used in futures trading to increase capital efficiency. For example, if you want to purchase 1 bitcoin (around $20,000 worth), but have only $1000 on your account, you can borrow the remaining $19,000 from the exchange (20x leverage).
Spot trading, on the other hand, does not offer leverage. You simply exchange your existing assets for other assets at the current market price. Therefore, to buy 1 BTC on spot market you will need exactly $20,000. At the same time, on futures market, only 10-15% of that amount is required to open a position for 1 BTC.
Spot Price VS Future Price
All transactions on the spot market are made at the current price, which is calculated depending on supply and demand.
The futures price consists of the basic spot price plus the futures premium. The futures premium can be either positive or negative. A positive premium indicates that the futures price is above the spot price. Conversely, a negative premium indicates that the futures price is below the spot price. A change in the balance of supply and demand can result in a change in the futures premium.
Since a futures contract is essentially a contract for a future transaction at a specific price, there is a possibility that on the date of the settlement, one party will fail to fulfil their obligations.
In the spot market the settlement takes place automatically here and now where the exchange has the role of the guarantor. And in the case of the OTC market in a P2P transaction, there are protective mechanisms, such as escrow service.
Long or Short Flexibility
After buying assets on the spot market, you can only make money by increasing the assets’ value. Futures, on the other hand, are a more flexible instrument. They allow you to earn even on the bearish market. In this case, you can make money by opening a short position. This feature also allows you to use futures contracts to hedge against market volatility.
Since you have the ownership of the cryptocurrencies purchased on the spot market, you are entitled to all the rights connected to the asset, including forks, staking, and airdrops. In case of a cryptocurrency fork, you will receive the coin of the new blockchain branch. For example, in 2017 for each bitcoin (BTC), an owner got 1 Bitcoin Cash (BCH). Of course, futures traders are not entitled to forks, since they own contracts, not the underlying assets.
In both spot and futures markets, there are two main parties involved in the transaction: the buyer and the seller. Spot transactions can be executed without intermediaries. For instance, P2P platforms allow for intermediary-free trading.
Futures transaction require an intermediary because of the use of leverage. The intermediary is usually a centralized exchange or a smart contract if the position is opened on the DEX.
Typically, commissions for spot trades have a simple structure. For example:
Trading fee = 1 BTC * 0.1% = 0.001 BTC
However, the amount of fee depends on your order type. If you place a limit order, then you will be a maker. Most platforms offer either zero or very low fee for makers. Makers are rewarded with lower fees as they add liquidity to the exchange by filling the order book.
If you trade using market orders, then you are a taker. Higher fees apply to takers as they take out the liquidity from the order book.
The maker/taker rules apply to the futures market as well. However, the fee structure is a bit more complicated. Traders pay a fee both for opening a position and for closing it. Thus, the Notional Value of the position is included in the fee calculation equation:
For example, Commission Fee = Notional Value * Fee Rate;
Notional Value = (number of contracts * contract size) / open/close price.
Date of Delivery
While a spot transaction is settled here and now, futures’ settlement time may vary. The settlement usually occurs at or close to the expiration date. For example, monthly futures expire and settle on the last Friday of each month, while quarterly futures — on the last Friday of each quarter.
When the contract expires, buyers and sellers do not exchange the underlying asset directly. Instead, the futures exchange delivers all open positions at the settlement price (the price of the last hour moving average based on the index).
It is worth mentioning that futures can come without any delivery date (expiration). They are called perpetual futures or “perps”. With perps, users do not need to monitor the futures calendar. Position can be held indefinitely — until they are liquidated.
Both the spot and the futures market have many fundamental differences, despite the fact that both are extremely popular. Which one to choose depends primarily on your needs, experience, and trading strategies.
If you prefer long-term investing and are an active user of cryptocurrencies, the spot market is more suitable for you. But if you prefer to speculate on the price of cryptocurrencies, futures contracts might be your best bet. Experienced traders may exploit the opportunities of both markets.
*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.