Generally speaking, the spot market means that commodities are traded in the spot market and delivered immediately. The futures market, as the name suggests, refers to the delivery of commodities and futures contracts on a specific date in the future.
Spot and futures markets are terms used in financial markets, such as stocks or foreign exchange. But did you know that they are also the basis for shaping the crypto market?
The cryptocurrency market has also experienced ups and downs, especially the price of Bitcoin plummeted from around US$20,000 to US$3,000 after rebounding in 2017. Then there is the ever-changing regulatory adoption of Bitcoin. Until recently, the Bitcoin bull market soared to an all-time high of around $61,000. For most Bitcoin spot and futures market traders, this is still shocking.
So why is it so important to understand the difference between spot trading and futures trading?
What is the spot market?
The spot market is called the cash market because it processes payments immediately. In other words, the contract between the buyer and the seller will be executed on-site at the prevailing price and determined quantity.
Suppose Harry (the buyer) wants to buy bitcoins in the spot market with fiat currency (USD)-he needs to find a seller in U.S. dollars to trade. Therefore, Harry can go to the spot market of the crypto exchange to find a Bitcoin/USD trading pair by setting a limit order and executing it at a predetermined price and quantity.
In any case, the buyer and the seller make equal quotations in the spot market, and the transaction will be executed immediately.
Characteristics of the spot market
The crypto market runs 24/7, which means we can buy and sell cryptocurrencies at any time and any day. All transactions are settled at the dominant price called the spot exchange rate, which is the spot price in the spot market. Anyone who holds a spot market contract, if not satisfied with the current price, can hold it and find a better deal. But there should be a positive demand and supply for traders to execute trades.
Types of spot markets
There are two main spot markets: over-the-counter (OTC) and market transactions.
In encrypted trading, over-the-counter trading means that users can trade in a decentralized market without intermediaries. There is no need for a broker or any other centralized exchange in this process.
The over-the-counter market handles a huge volume of transactions and seems opaque out of the public eye. This is because transactions in the over-the-counter market are usually non-public. On the other hand, the implementation process is relatively simple. As long as the two parties agree on the price, transaction volume, and transfer method, the transaction can be conducted directly without the intervention of an intermediary.
What is the futures market?
The futures market refers to a market where a user and another party reach an agreement on the price of an asset on a certain date in the future. This speculation is placed on a specific day, but the transaction is not on the spot. Therefore, the user’s cryptocurrency can only be bought and sold at a specific price and date agreed in the futures contract.
Unlike the spot market, users trade contracts in the futures market, but do not actually own the relevant assets. In fact, futures contracts are to avoid market volatility. For example, when a user trades a BTC USD contract, the user is not actually buying or selling bitcoin, but based on the assumed value of BTC.
In other words, users pledged that the price trend of Bitcoin is parallel to the value of the contract without owning assets.
Characteristics of the futures market
The volatility of crypto trading is inevitable, which has always been a concern for many traders. However, price fluctuations provide traders with trading opportunities to predict price movements.
Derivatives are a form of futures contracts. Before signing the agreement, the buyer and seller must pre-determine the price and date. Hedging is common in futures contracts.
Understand the main differences
Understanding the key difference between the spot and futures markets is that they can be successfully traded. Once users understand their characteristics, they can easily identify the advantages and limitations of each financial opportunity.
Here are some highlights:
Spot and futures prices
Assuming that a user makes a transaction in the spot market, the transaction will be completed immediately. However, in the futures market, the user’s assets have a locked price in the future, and they are traded according to agreed terms.
Spot price fluctuations are based on the volatility of assets. For example, the spot price of Bitcoin can rise or fall sharply within minutes or hours. Therefore, when Tesla announced a large-scale investment in Bitcoin, the market rebounded.
A common assumption is that futures prices are usually higher than spot prices. But this is not always the case.
In fact, there are many factors involved in futures contracts before users start to guess asset prices and finally reach a transaction price. However, users should still decide whether or not to pledge futures prices will benefit them based on their real-world views on volatility and price arbitrage.
The delivery date is the expiry date of the futures contract. Simply put, this is the final date on which the futures contract must deliver the specified price and crypto assets. When the delivery date arrives, the contract holder must receive its underlying asset.
However, this date varies from contract to contract. Some traders or investors may set a specific day, while others may decide a month. If the user agrees to a delivery date within one month, the transaction must be conducted a few days before the end of the month.
Moreover, each delivery day has a unique code consisting of numbers and letters. The exchange will act as an intermediary, but the last two symbols will be month and year, in this order. However, according to the exchange, the last two symbols can be month and day.
However, if users decide to trade forward contracts instead of futures contracts, they need to trade or invest through the over-the-counter spot market. The forward contract allows the date to be adjusted with the consent of the buyer and the seller.
Margin and leverage
If a user wants to use leverage in the spot market, the user must first purchase cryptocurrency and pay transaction fees in accordance with the exchange’s regulations. However, it is necessary to point out that their loan funds are not sufficient. This means that the leverage provided is usually not too high, because their loan balance is not too high.
On the other hand, there are sufficient funds in the borrowing pool of the futures market, which means they can provide higher leverage.
When users use leverage in a futures contract, they do not need to pay the full amount of the contract. The user can enter a specific percentage of the total contract value, which is the initial margin amount.
Note: The initial margin is the amount of guarantee required to open a position for leveraged trading.
The initial margin is usually between 3% and 12% of the total contract value. But every exchange’s situation is very different.
Whether users end up trading cryptocurrencies in the spot market or through market trading futures contracts, it is necessary to understand the risks. The goal of every trader or investor is to minimize risks and maximize returns.
One situation that users may encounter is counterparty risk. This means that the other party is not fulfilling its obligations. This may be because the other party either cannot meet the conditions or is unwilling to give back to the other party.
However, because futures contracts mean that users trade through intermediaries, they are less likely to encounter counterparty risk because their value is based on market exchange rates.
On the other hand, forward contracts are not regulated by the market like futures. They are agreed upon by the buyer and the seller. When the cryptocurrency is exchanged, these contracts are completed, which means that the user can only know the user’s profit and loss when the date arrives.
Parties involved in the transaction
Apart from the user as an individual trader, are there anyone else involved?
The answer is yes, and the correlation is very significant.
Both the spot market and the futures market have two major transaction participants; a buyer and a seller. The spot market prides itself on instant transactions. So when the prices of buyers and sellers match, the transaction is executed.
As for the futures market, intermediaries are often involved in this process.
When it comes to transactions, fees are always an issue. This is because they will accumulate and reduce the user’s overall revenue.
Spot market cryptocurrency transactions usually charge a transaction fee of 0.1% to 0.2%. There may also be transaction fees that depend on the total transaction volume of buyers and sellers in the market.
In addition to transaction fees, futures contracts usually also have a settlement date. When the settlement date is reached, all positions must be closed. Therefore, when the trader decides not to close the position manually, the system will automatically close the position when the closing date is reached. A settlement fee will be charged for open positions.
Is the futures market better than the spot market? It depends on the user’s needs and trading strategy.
Same-day trading may better match the spot market, where users can immediately buy and sell on a regular basis. But if users are more willing to guess the price of cryptocurrencies, then futures contracts may be a better choice.
Having a clear understanding of the trading market, coupled with controlling emotions, will produce the best results.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/crypto-trading-comparison-of-spot-market-and-futures-market/
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