Cryptocurrency exchanges are the best place to buy, sell, and trade cryptocurrency assets like bitcoin and ethereum. As a cryptocurrency trader, you must be familiar with the concepts of Spot trading and Futures trading. Learning various crypto concepts and trading strategies can be a lifelong process. In the cryptocurrency market, spot and futures trading are critical ecosystems. Understanding the distinction between them is one of the first steps toward becoming a savvy crypto trader.
What is Spot trading?
The process of purchasing and selling virtual currency such as Ethereum or Bitcoin for immediate delivery is referred to as crypto spot trading. This means that traders directly exchange cryptocurrencies by buying and selling them. You have direct ownership of cryptocurrencies in a cryptocurrency spot market as a trader, as well as legal rights such as staking or voting on major forks.
Spot exchanges act as intermediaries for users who want to bid on or seek a crypto asset. When the bid or offer is matched, the transaction is facilitated by the exchange. They are available 24/7, so you can spot trade at any time.
The spot market is a market for trading financial instruments such as commodities, currencies, and securities for immediate delivery. Investors in the bitcoin spot market own, buy, and sell actual bitcoin. Basically, it is the underlying market in which bitcoins are traded.
What is Futures trading?
Trading contracts or agreements that represent the actual value of a specific cryptocurrency is known as crypto futures trading. When you purchase a crypto futures contract, you do not own the underlying cryptocurrency but rather agree to buy or sell specific crypto at a future date.
In contrast to crypto spot trading, crypto futures trading does not provide you with benefits such as staking or voting. As you must be knowing, the crypto market is extremely volatile, and crypto futures contracts protect you from volatility and negative price movements on the asset in question. Futures contracts are also a proxy tool that allows the users to speculate on the potential value of a particular cryptocurrency.
That means you can profit from cryptocurrency volatility. To put it simply, if you believe the value of an asset will rise, you will purchase a futures contract to go long, and if you believe it will fall, you will sell to go short. As a result, the accuracy of your prediction determines your profit or loss.
Investors in the bitcoin derivatives market enter into an agreement or contract to buy bitcoin at a pre-decided time and price in the future. Investors in this market do not own actual bitcoins but rather trade on the speculative price of bitcoin. Bitcoin contracts, which can be futures, perpetual contracts, swaps, or options, derive their value from the price of bitcoin.
Difference Between Spot trading and Futures trading
Understanding the key differences between the spot and futures markets is critical to making a profitable trade. Once you understand their characteristics, you can easily identify the benefits and drawbacks of each of these financial opportunities.
Let’s learn about some of the key differences between spot trading and futures trading:
- Leverage– Futures trading is highly capital-efficient due to leverage. You can open a 1 Bitcoin futures position for a fraction of its market value using a futures contract. In contrast, spot trading does not offer this form of leverage. A futures exchange’s sole purpose is to maintain a balance between buyers and sellers, with no restrictions on the amount of capital that can be speculated on.
- Long or short flexibility– If you own cryptocurrencies on the spot market, you may benefit from capital appreciation as their value grows over time. On the other hand, futures contracts let you profit from both short- and long-term price fluctuations. Even if Bitcoin’s price decreases, you can profit from the decline as prices continue to fall. Futures contracts can also shield long-term investors and miners from unanticipated risks and price volatility.
- Liquidity– The crypto futures markets offer ample liquidity, with monthly volumes in trillions of dollars. The Bitcoin futures market, for example, has a monthly turnover of $2 trillion, which exceeds Bitcoin spot market trading volumes. Its strong liquidity promotes price discovery and allows traders to transact in the market quickly and efficiently.
- Spot trading vs. Futures trading prices– Buyers and sellers determine cryptocurrency prices through an economic process of supply and demand. The spot price is the price at which all transactions in the spot market are settled. In contrast, the futures price is calculated by adding the current spot price to the futures premium. The futures premium may be positive or negative. A positive premium means that the futures price is higher than the spot price; a negative premium means that the futures price is lower than the spot price. Future premiums may fluctuate due to changes in supply and demand.
- Commodities– The debate over spot versus futures commodities is best understood based on your perspective on the commodity. If you want to trade price movements in commodities, the futures market is a much better option than the spot market. Trading in the spot market can be time-consuming and costly, and trading profits can be significantly reduced. With their more structured approach, lower costs, and higher leverage, Commodity futures can assist in executing a trade in a granular and smarter manner.
- Counterparty Risks– You must be aware of the risks of trading cryptocurrency on the spot market or futures contracts through market exchange. The goal of every trader or investor is to minimize risk while maximizing gains. Counterparty risk is one of the scenarios you could find yourself in. That means the other party is not fulfilling their obligations. This could occur if the opposing party is either unable to meet the terms or unwilling to reciprocate.
Crypto spot trading is a great place for beginners. On the other hand, Crypto futures trading necessitates extensive knowledge and risk management strategies to avoid significant losses.
Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn’t represent any investment advice or WazirX’s official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.