Perpetual Futures vs Margin Trading
What is Margin Trading?
Margin trading is essentially borrowing money to trade with. In a traditional spot trade on a crypto exchange, you deposit money into your account, and then use that money to buy or sell an asset. When you trade on margin, instead of depositing all the funds needed to open a position upfront, you instead deposit a much smaller amount and borrow the rest from the exchange.
The portion of your funds that corresponds to this borrowed amount is called leverage. The remaining portion of funds in your account (that are not being used as collateral for the position) is called equity.
The amount of leverage offered by an exchange varies from one exchange to another, but typically ranges from 2x up to 100x leverage (the latter is extremely rare). The most common form of leverage offered by exchanges these days is 5x & 10x for perpetual futures contracts and 20x for margin trading in spot markets.
What are Perpetual Futures Contracts?
Perpetual futures are a type of derivative contract that allows traders to speculate on the future price of bitcoin (BTC) or other cryptocurrencies without requiring them to actually own any of the underlying assets.
These contracts can be used by traders as a way of hedging their risk in order to protect against volatility, or as a way to profit from price movements.
Perpetual futures are similar to traditional futures contracts, but differ in that they do not have an expiration date and therefore never settle. They trade similarly to spot markets, and the only difference is that futures permit trading with leverage. As such, perpetual futures are traded on a cryptocurrency exchange instead of a traditional regulated derivatives exchange like CME or CBOE.
In addition, perpetual futures differ from traditional futures contracts in that they offer no margin call which means if you’re over-leveraged and get liquidated you lose all your money at once, whereas with traditional exchange leverages exchanges you’ll be taken down gradually until your position is flat. This makes perpetual futures markets more risky than the existing BTC exchange options such as BitMEX, Deribit etc., because if your position goes bad there’s no margin call and you could lose everything at once rather than being able to hold out for it go back up again so it can close at zero loss when you’re long and short simultaneously.
What are the Differences Between Perpetual and Margin Trading?
The first difference between traditional margin trading and perpetuals is that with a perpetual you can trade long or short, whereas in margin trading you are only able to go long. The second major difference between these two products is the fee structure. Margin trading involves a daily interest charge on the amount of money borrowed based on its duration. With margin trading the broker will have a fixed interest rate which is applied to any position that is held overnight.
Perpetual contracts also have a premium, called funding, which goes to whoever trades in the direction of bitcoin’s spot price and needs to be paid every 8 hours. Another important distinction to note is that unlike with margin trading, there are no expiry dates for perpetual contracts so they can be held indefinitely with no cost beyond funding fees (if traded against the index).
Pros and Cons of Margin Trading
- You can earn more with margin trading
- You can engage in leveraged trading
- More opportunities to make money (arbitrage, etc.)
- More liquidity
- Higher risk of liquidation
- High leverage means you may lose all your funds
- Less liquidity, since there is no funding rate
- More risk because your position is always open and liquidated if the price does not go up high enough
Pros and Cons of Perpetual Futures
If you’re interested in perpetual futures, here are some pros and cons of the model that you should keep in mind.
- High leverage — up to 100x on most exchanges
- No risk of bankruptcy — these contracts do not have a liquidation price or an insurance fund, so there is no risk of you losing more than your initial margin amount if the market moves against you
- No expiry date — since there are no liquidation prices for perpetual futures contracts, they never expire and can be closed at any time (unless you want them to expire)
- No need for a margin account or futures account — unlike with regular futures contracts which require both a margin account and futures account to trade them on an exchange like BitMEX, all that’s needed in order to trade perpetuals is your personal BTC balance (though if you want higher leverage then it would be better to use one)
Difficult to hedge — since perpetuals do not expire and there is no liquidation price for them, this means that they cannot be hedged by trading traditional derivatives such as options or swaps; instead it may be possible to hedge using other types of derivative instruments like CFDs (or even just using cash) but these will incur additional costs due to their complexity (as we’ll see below). This makes it harder for traders who need protection against adverse movements in spot prices without having access to traditional products like options which have expiration dates set by the exchange itself at which point hedges become invalidated automatically. Traders must either consider using another type
Which Should you Pick?
Before choosing a perpetual futures contract or margin trading, it is important to consider your needs and goals. This decision will depend on your risk tolerance, the time you have available to trade and the features you prefer.
Trading Perpetual Futures
Most perpetual futures contracts are on digital assets like Bitcoin and Ethereum, but you can also find them for gold and crude oil. These contracts are traded around the clock, allowing you to capitalize on short-term price movements no matter where in the world you live. Because of their many benefits and low fees, perpetual futures contracts have gained popularity over traditional margin trading in recent years. If you want to minimize risk while maximizing returns, these contracts could be a good fit for your portfolio.
If instead of hedging against market volatility or seeking long-term gains by owning an asset outright, all you want is a quick return on investment through day trading — margin trading may be the best option for your needs. Margin accounts allow access to leveraged positions that increase earnings potential if used correctly but come with higher fees than most other types of accounts offered by brokerage firms