The world of cryptocurrencies is immensely populating with many crypto coins and tokens now. And this trend has been fast paced since last decade with individual and institutional investors pouring in and showing immense interest. As the crypto market flourishes and continues to evolve, so do the ways in which traders engage with it. Two popular methods include trading cryptocurrencies with leverage such as by margin trading also called in some cases as futures trading. In this article, we will explore the key differences between margin trading and futures trading in crypto space.
Basics of Margin Trading
Margin trading is a method that allows traders to borrow funds and amplify the trading positions. In this context of cryptocurrency, margin trading involves borrowing funds at a specific amount of crypto or fiat currency from a broker or an exchange to increase the size of trading position. This allows traders to potentially earn a larger profit when the market is in their favor.
Advantages of Margin Trading in Crypto
Margin trading allows traders to take part in holding on to larger positions and sizes with small capital outlay. This can increase the potential gains when the market moves in the desired direction.
Margin trading permits many traders to profit from falling crypto prices by borrowing assets and then selling them at a higher price, with an initiation of buying them back at a lower price.
It provides more flexibility by allowing traders to access a wide range of cryptocurrencies, including those with lower liquidity.
Low Entry Barrier
Margin trading typically involves a lower entry barrier as compared to futures trading, making it more accessible to novice traders.
Disadvantages of Trading in Crypto
Risk of Liquidation
While margin trading can amplify gains, it can also amplify losses. If the market moves against a trader’s position, they risk being liquidated and losing their initial investment.
Interest and Fees
Borrowed funds produce interest, and traders may need to pay fees to maintain a margin position.
Crypto market is known for its extreme volatility. Margin trading can be riskier due to the rapid price swings.
Crypto markets are susceptible to manipulation and margin traders may be more vulnerable to such risks.
Basics of Future Trading
Futures trading involves buying and selling contracts that obligate traders to buy and sell a specific amount of cryptocurrency at a predetermined price and date. Such contracts, commonly referred to as future contracts, thus deriving their value from underlying cryptocurrency. Futures trading allows traders to speculate on the future price of cryptocurrencies without owning the underlying asset.
Advantages of Futures Trading in Crypto
Like margin trading, futures trading offers leverage, enabling traders to control a larger position with a smaller amount of capital.
Futures contracts can be used as a hedging mechanism and tool to mitigate risk. Traders can use them to protect their holdings from adverse price movements.
Unlike margin trading, there is no liquidation risk in future trading. Traders can hold the positions until the contract’s expiration date.
Many futures trading platforms are regulated and that can provide a sense of security to traders.
Disadvantages of Futures Trading in Crypto
Futures trading is more complex than margin trading, and novice traders may find it challenging to understand how future contracts work.
Futures contracts have an expiration date, which means that traders need to manage and roll over their position if they want to maintain exposure to a specific cryptocurrency.
Lack of Ownership
Traders in a future market do not own the underlying asset, which means that they do not benefit from the dividends and voting rights associated with the asset.
Future trading involves a counterparty, in this case the exchange, which carries its own risks. If the exchange experiences technical issues or goes bankrupt, it can affect your positions. Your positions are more prone to liquidation just like as happened in the case of FTX scam.
Margin Trading vs Future Trading: Which is Better for Crypto?
Choice between margin and futures trading in crypto space is dependent on a trader’s risk tolerance, experience, and investment goals. To help you with the method that suits you best can be better for your needs.
In margin trading there are higher chances of liquidation, due to real-time margin maintenance, whereas in future trading the trader can hold positions until the contract expires without the risk of liquidation. If you have a lower risk tolerance, you need to opt in for futures.
Knowledge and Experience
Both margin and futures trading require a good understanding of market and trading principles. However, futures trading is considered more complex with its own unique set of terms and mechanics. Novice traders may prefer to start with margin trading and gradually transition to futures trading, as they gain experience and confidence.
Liquidity and Diversification
If you are looking to diversify your crypto portfolio and trade a wide range of assets, margin trading can be more suitable. It offers more flexibility, allowing you to trade various cryptocurrencies with varying levels of liquidity. Future markets, on the other hand, may not always offer as many trading pairs.
Futures trading includes advantages and risk management due to the absence of liquidation risk. Traders can define their risk and stop loss levels without worrying about sudden liquidations. In contrast, margin trading needs to be closely monitored and maintained for adequate margin levels to avoid liquidation.
Short Term vs Long Term
The choice between margin and future trading can be influenced by your trading horizon. Margin trading is often favored for short term trading due to its flexibility, whereas futures trading is suitable for both short term and long-term trading strategies. This depends on the contract’s expiration.
In some regions and jurisdictions, there may be different tax implications for margin trading and futures trading. Consult with a tax professional to understand how each trading method might affect the tax liability.
Market conditions and cryptocurrencies prices tend to play a decisive role in making a smart decision. As crypto markets are extremely volatile, there are risks of liquidation, while futures margin trading can be heightened, and thus provides a degree of protection.
In summary there is no one-size-that-fits-all-answer. It depends on the trader whether they seek to go for crypto margin trading or futures trading. It depends strongly on your individual preferences, risk tolerance, and investment goals. Some traders may prefer the flexibility and simplicity of margin trading, while others may prefer risk management and security as pinnacles of importance for future trading.
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