Crypto traders love to “monkey” and make “degenerate” investments by using high leverage in the futures markets, but most traders fall prey to these three main mistakes.
Many traders often make some pretty big misconceptions about cryptocurrency futures trading, especially on derivatives exchanges outside of the realm of traditional finance. The most common mistakes are related to price allocation in the futures markets, fees and the impact of liquidation on the derivative.
Let’s take a look at three simple mistakes and misconceptions traders should avoid when trading crypto futures.
Derivative contracts differ from spot trading in pricing and trading.
Currently, the cumulative open interest in futures in the cryptocurrency market exceeds $25 billion, and retail traders and experienced fund managers are using these tools to increase their positions in cryptocurrencies.
Futures contracts and other derivatives are often used to reduce or increase risk and, despite this popular interpretation, are not really intended for use in degenerate gambling.
Some price and trading differences are generally not accounted for in crypto derivative contracts. For this reason, traders should at least consider these differences when entering the futures markets. Even savvy investors in conventional investment derivatives are prone to making mistakes, so it’s important to understand the ins and outs before using leverage.
Most cryptocurrency trading services do not use US dollars, even if they display quotes in US dollars. This is a major undiscovered secret and one of the pitfalls that derivatives traders face, adding additional risk and distortion to trading and analyzing futures markets.
A pressing issue is the lack of transparency, so clients don’t really know if contracts are listed in stablecoins. However, this shouldn’t be a huge problem as there is always an intermediary risk when using centralized exchanges.
Discounted futures sometimes surprise
As of Sept. 9, Ether (ETH) futures expiring Dec. 30 are trading at $22, or 1.3% below the current price on spot exchanges such as Coinbase and Kraken. The difference comes from waiting for the merge fork coins that can occur during an Ethereum merge. Derivatives contract buyers will not receive any of the potentially free coins that Ether holders can receive.
An airdrop could also cause futures prices to fall as derivative contract holders are not rewarded, but this is not the only case of a split as each exchange has its own pricing mechanism and risks. For example, Polkadot Quarterly Futures on Binance and OKX trade at a discount compared to the Polkadot (DOT) price on spot exchanges.
Quarterly premium for Binance Polkadot (DOT) futures. Source: Trade View
Note that the futures contract traded at a discount of 1.5% to 4% between May and August. This backwardation shows the lack of demand from leverage buyers. However, given the long-term trend and the fact that Polkadot is up 40% from July 26 to August 12, external factors are likely to come into play.
The price of a futures contract is decoupled from spot exchanges, requiring traders to adjust their targets and entry levels when using quarterly markets.
Higher fees and price sharing should be considered.
The main benefit of futures contracts is leverage, or the ability to trade amounts in excess of the initial deposit (collateral or margin).
Consider a scenario where an investor has invested $100 and buys $2,000 worth of (long) Bitcoin (BTC) futures with 20x leverage.
While trading fees for derivative contracts are typically lower than spot tokens, a hypothetical commission of 0.05% applies to a $2,000 trade. Thus, entering and exiting a position once costs $4.00, which is 4% of the original deposit. It may sound little, but such losses weigh when sales soar.
Even when traders understand the additional costs and benefits of using a futures instrument, the unknown element usually only shows up in volatile market conditions. The separation of futures contract and conventional cash exchanges is usually done by liquidation.
When the trader’s margin is no longer sufficient to cover the risk, the futures exchange has a built-in mechanism to close the position. This Liquida