Traditional Futures vs. Crypto Futures — What Are The Similarities and Differences?
While traditional futures have a long-standing history as a reliable asset class capable of generating both short and long-term returns, cryptocurrency futures are a relatively new financial instrument that bear some similarities to traditional futures, but also some differences too. In recent years, cryptocurrency futures have been seen as an alternative to more conventional assets. However, it’s worth noting that both markets can offer profitable strategies. In this article, we’ll delve into the key differences between traditional futures vs. crypto futures.
Traditional Futures
A traditional futures contract is an agreement between two parties to buy or sell an underlying asset, such as a commodity, stock index, or currency, at a predetermined date in the future at a price agreed upon today. The buyer of the contract is obligated to take delivery of the asset according to the terms of the contract, while the seller is responsible for delivering the asset.
These Futures contracts are typically traded by individuals or entities with an interest in the underlying asset. These contracts serve to hedge against potential risks or to secure profits. For instance, a farmer may sell a futures contract for their grain harvest to guarantee a certain price for their crop three months later in anticipation of falling market prices. Alternatively, a livestock farmer may buy a futures contract to secure a certain price for winter feed supply in anticipation of rising market prices.
Suppose the current price of grain is $70. In the case of the grain farmer who sold a futures contract, the market price drops to $50 three months later. However, the farmer can still deliver the harvested grain at the predetermined price of $70 under the futures contract. Conversely, in the case of the livestock farmer who bought a futures contract, the market price of grain rises to $80 three months later. Nonetheless, the farmer can still buy their winter feed supply at the agreed-upon price of $70 under the futures contract.
Trading futures contracts entails profiting from the difference between the buying and selling prices of the contracts without necessarily owning the underlying asset.
Crypto Futures
Crypto futures contracts enable market participants to buy or sell a cryptocurrency asset at a specific date and time in the future. These contracts are primarily designed to mitigate the risk of future price changes in an asset.
The most common way to trade crypto futures is Speculation. For example, if a trader anticipates a bullish market, they may choose to go long on a futures contract, while a bearish market outlook might prompt them to sell a futures contract. Utilizing leverage through futures contracts allows traders to amplify their potential profits, but it also exposes them to the risk of greater losses.
Consider this example: A trader buys a futures contract on a stock with a contract multiplier of 2,000 and an initial margin requirement of $8,000. Assuming the contract price is $100, the leverage of the futures contract would be ($100 x 2,000/$8,000) = 25 times. If the price increases by 10%, the trader’s gain would be amplified by 25 times, resulting in a 250% gain. Conversely, if the price drops by 10%, the trader’s loss would also be magnified by the same multiple.
Apart from hedging price risk, futures contracts also offer traders the opportunity to profit from speculation and arbitrage. However, before diving into futures’ functions and trading strategies, it’s essential to understand the basics of a futures contract.
Key Similarities
Both traditional and crypto Futures trading serves two primary purposes: speculation and hedging. While most retail traders engage in crypto futures trading for leveraged speculation, it is essential to remember that the primary objective of traditional futures contracts is hedging.
Hedging through traditional futures is a technique utilized by most professional money managers. However, there is a significant challenge with crypto futures hedging, namely that the settlement price of futures contracts does not necessarily match the actual spot price of their underlying asset.
In other words, the price basis utilized by futures contracts is derived from the actual price, known as the “settlement price,” and not the underlying asset’s current price. The issue with the settlement price is that it may vary significantly from the actual price of the underlying asset, which can create challenges when using futures contracts for hedging.
Key Differences
The difference between traditional and crypto futures trades lies in their market structures. Traditional markets are regulated, while crypto markets are unregulated. Regulated markets have laws and standards to ensure the legitimacy of exchanges, which can slow trade processes. In contrast, unregulated crypto markets allow for perpetual swaps, which are futures contracts without an expiration date, and investors can capitalize on market changes at any time due to the 24/7 trading availability.
Another notable difference is the trading hours. Traditional markets are closed for about 13 a day, making it impossible to trade assets or change positions during that time. Conversely, crypto-assets can be traded at any time of the day or year since markets never close.
Which One Is Better?
When comparing traditional futures and crypto futures, it is important to note that both are pretty much similar. This said, the crypto futures market is inherently more volatile, resulting in wild market swings, whereas the traditional futures market is less volatile.
Trading assets with frequently fluctuating prices are suitable for the crypto futures market, as they provide more trading opportunities. The traditional (stock, forex, commodities) futures market, with relatively less volatility, offers fewer trading opportunities. High market volatility can provide investors with more significant potential profits, but it also increases the risk of significant loss, making trading more risky.
Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.
