What is Contract Trading in Crypto? How does it work?

Contract trading refers to a financial arrangement where parties agree to buy or sell an asset at a predetermined price on a future date. These agreements, often standardized and traded on exchanges, enable investors to speculate on price movements without owning the underlying asset. 

Contracts typically include quantity, quality, delivery terms, and settlement procedures. However, the crypto market is extremely volatile, and it requires adherence to specified terms and conditions through legal frameworks and exchange regulations.

KEY TAKEAWAYS

• How contract trading works in crypto.
• Differences between long-term and short-term contracts.
• Leverage, risks, and rewards in trading.
• Explore different types of crypto futures and options.

What is Contract Trading?

Contract trading, also known as margin trading, lets you leverage the power of borrowed funds from an exchange to amplify your returns in the cryptocurrency market. In this case, the traders begin with a small initial investment but have the potential to control a much larger amount of Bitcoin (or other crypto). This increased buying power comes with a catch, the exchange. 

By entering a legal contract, the exchange agrees to offer you additional capital, multiplying your buying power. However, there is a risk-reward balance. If your trade goes well, the exchange pays you the difference based on the larger amount. But if the trade does not work well, you are on the hook to repay the borrowed funds. This leads you to potentially lose your initial investment and even some of your crypto holdings deposited as collateral.

Let us understand the concept with an example. 

Say you want to buy 1 Bitcoin for $40,000 but only have $400. The trading platforms offer a leverage option that acts like a loan. With 100x leverage, they lend you $39,600 to buy the Bitcoin.

A small price movement (just 1%) could trigger a liquidation, where platforms take back the Bitcoin and your $400 collateral. With lower leverage (like 3x), you have more wiggle room Bitcoin’s price could drop 10% before liquidation. 

How Do Long and Short-Term Contract Trading Work?

Long and short-term contract trading in cryptocurrency leverage futures and options contracts to capitalize on price movements. However, the working mechanism of both is completely different.

Long-Term Contracts

• Long-term contracts hold positions for weeks, months, or even years. This makes it suitable for those with a long-term outlook on the crypto market
• This option often involves holding futures contracts with an f that the price will rise or using options contracts to hedge existing crypto holdings against potential price drops.

Short-Term Contracts

• The short-term contracts have open and closed positions within minutes, hours, or days. This volatility is ideal for experienced traders comfortable with capitalizing on short-term price fluctuations.

How does Contract Trading Work?

Contract trading works mainly through two instruments, Crypto Future and Crypto Options. The former can be ascertained as a binding agreement wherein you commit to buy or sell a cryptocurrency at a predetermined price on a future date. 

The settlement typically happens in cash, where you receive or pay the difference between the agreed price and the market price at expiry. Crypto options, on the other hand, provide more flexibility. They grant you the right, but not the obligation, to buy or sell a cryptocurrency at a certain price by a specific date. This option offers a controlled-risk approach that suits those who want to hedge existing holdings or make strategic bets with a defined maximum loss.

Different types of Crypto Futures Contracts

Crypto Futures: A Binding Agreement

Crypto futures lock you into a contract, this is because you agree to buy or sell a specific cryptocurrency at a predetermined price on a future date. For instance, you pre-order Bitcoin at a fixed cost for delivery later. These contracts typically settle in cash. 

READ MORE: A Complete Beginners Guide To Crypto Futures: Guide To Bitcoin & Crypto Futures

On the expiry date, you’ll receive or pay the difference between the agreed price and the market price. However, this magnifies both potential profits and losses. Therefore, this makes them suitable for experienced traders comfortable with active management and directional bets, futures are a high-risk, high-reward game.

Crypto Options: Flexibility with Defined Risk

Crypto options offer more control over the assets as compared to crypto futures. With this, you can get the right but not the obligation to buy or sell a cryptocurrency at a pre-defined date. 

You can consider your crypto option as an insurance policy wherein you have a premium to pay. Whenever the market moves up or down, you can buy or sell the holdings. This controlled-risk approach is better for those seeking to hedge existing crypto holdings or for strategic speculation with a defined maximum loss.

READ MORE: Crypto Options Trading For Beginners: A Complete Guide 

Benefits of Contract Trading in Cryptocurrency

While contract trading in cryptocurrency carries significant risks, it also offers several advantages for experienced investors seeking to navigate the volatile crypto market. Here are 5 key benefits to consider:

1. Gaining from Price Fluctuations

Unlike traditional stock investing where you profit from price increases, contract trading allows you to speculate on both rising and falling prices. With futures contracts, you can enter a short position, essentially betting that the price will decrease. 

2. Potential for Leverage

Contract trading platforms often allow leverage, meaning you can control a larger contract size with a smaller initial investment. This leverage can magnify your profits if the market moves in your favor. However, it is crucial to remember that leverage also amplifies losses, so responsible risk management is essential.

3. Hedging Existing Crypto Holdings

Contract trading offers you a good hedging strategy. This is because entering into a short futures contract on the same asset you hold, and approach helps mitigate risk in your overall crypto portfolio.

4. Increased Capital Efficiency

Contract trading allows traders to more efficient use of funds which makes it a great option for spot trading. With a smaller initial investment through leverage, you can control a larger position, potentially amplifying your returns. 

5. Short-Term Trading Opportunities

Contract trading is a great alternative for active traders who want to capitalize on short-term prices. They know the basic process of entering and exit position which is a great option to leverage on cryptocurrency. However, short-term trading requires significant skill, experience, and a deep understanding of technical analysis.

Risk of Contract Trading in Cryptocurrency

Contract trading Cryptocurrency offers capital appreciation potential but also has its own sets of benefits and risks. Here are some risks that you should be well versed with before choosing it.

1. High Volatility

Cryptocurrencies are extremely volatile which means that the price fluctuates very aggressively. Citing this volatility, investing in cryptocurrency is extremely challenging as it increases the risk of losing in trading. 

2. Leverage

While doing contract trading in cryptocurrency, you can use the leverage offered by the platform to control a large contract size with a small investment. In this way, you can magnify your losses but works the same way for profits as well.

3. Margin Calls and Liquidations

When using leverage, your exchange might issue a margin call if your account value falls below a minimum threshold. This lets you deposit more funds or liquidate your position to meet the margin requirement.

4. Liquidity Risk

Liquidity refers to the ease with which you can enter and exit a position. While major cryptocurrency futures and options markets offer good liquidity, some less popular contracts might have lower liquidity. This can make it difficult to find a buyer or seller for your contract at your desired price, potentially leading to missed opportunities or unfavorable execution.

5. Exchange Risk

Cryptocurrency exchanges are relatively new as compared to traditional financial markets. Thus there’s a risk of exchange hacks, technical glitches, or even exchange closures. This could impact your contract positions and access to your funds. 

What distinguishes futures trading from other types of crypto trading?

Crypto Futures vs. Commodity Futures

Crypto Futures and commodity futures are both similar but they cater to different asset types. For instance, both of them come with a pre-defined contract to buy or sell the asset at a predetermined future price. However, crypto futures deal in volatile cryptocurrencies like Bitcoin. Whereas, commodity futures are usually used to buy physical goods like oil or wheat. Crypto trades are highly volatile but are a great tool for those looking for a high profit through speculations. 

Crypto Futures vs. Crypto Options

Crypto futures and crypto options both involve speculating on price movements, but futures contracts obligate you to buy/sell at the expiry date. Crypto futures are high-risk, and high-reward due to leverage, which magnifies both gains and losses. Whereas, options offer more control and limit potential losses to the option’s premium cost. However, investing in crypto options is for those who have a deeper understanding of option strategies and factors affecting option prices. 

Crypto Futures vs. Spot Trading

Crypto futures and spot trading represent fundamentally different approaches to cryptocurrency. Spot trading involves the immediate purchase/sale of crypto, transferring ownership to your digital wallet. This means you own the asset that will be subjected to price appreciation over time. 

Crypto futures, on the other hand, are contracts to buy/sell at a future date, allowing you to speculate on price movements without immediate ownership. Futures can be used to profit from both rising and falling prices, but come with the risk of significant losses due to leverage.

Where to Trade Crypto Futures?

Several cryptocurrency exchanges offer futures trading, but choosing the right one depends on your experience and needs. Here are a few popular options to choose from:

• Binance Futures and Coinbase offer high liquidity and user-friendly platforms but might have complex features for beginners
• You should look for exchanges regulated by financial authorities for added security when trading crypto futures
• Finally, consider the level of leverage you need when trading. While it can amplify gains, it also increases potential losses for the traders

In conclusion, if you are ready to explore the world of contract trading in cryptocurrency, Mudrex is the perfect platform to begin your trading journey. With its user-friendly interface, comprehensive educational resources, and advanced trading tools, Mudrex provides an ideal place for both new and experienced traders to thrive. 

Download the Mudrex app from the Google Play Store today to kickstart your Crypto trading journey and take the first step towards cryptocurrency trading. 

FAQs

What does a trading contract mean?

A trading contract is a legally binding agreement between two parties to buy or sell an asset at a predetermined price by a specific future date. It allows speculation on price movements.

What is a contract in cryptocurrency?

An agreement to buy or sell a specific amount of cryptocurrency at a set price on a future date. This lets traders bet on price changes without directly owning the cryptocurrency.

How to trade crypto contracts for beginners?

Trading crypto contracts is not recommended for beginners due to the high risk and complexity. Hence, beginners should research thoroughly, understand the risks, and start with smaller investments in regular cryptocurrency purchases.

Is crypto contract trading legal?

Yes, crypto contract trading is legal since the Indian government does not have any rules or laws for the crypto market.

How much is 1 contract in trading?

The value depends on the underlying asset and contract details. For example, a Bitcoin contract might represent 1 whole Bitcoin, while another might represent a fraction.