What is contract trading?
Contract trading is a derivatives trading method of virtual currency that allows investors to participate in virtual currency transactions through long, short, and leverage methods. It helps investors to amplify profits when prices rise and also make profits when prices fall. By adding leverage, investors can participate in greater market fluctuations with relatively small funds.
Due to the design of contract trading rules, the price of virtual currency in contract trading will be different from the price of spot trading. This is normal. When prices fluctuate extremely, the price difference will be large, so when participating in contract trading, you need to assess the risks.
How does contract trading work?
The underlying logic of contract trading is to allow investors to borrow fiat currency or virtual currency and buy or sell virtual currency at a specific price at a specific point in the future.
For example, Xiaoyu has 100 USDT, and Xiaoyu believes that the price of Bitcoin will rise from 100 to 200 tomorrow. At this time, Xiaoyu can borrow 900 USDT from the exchange, then use the 1,000 USDT to buy 10 Bitcoins, and then sell them when the price rises to 200 tomorrow. After selling, there will be 2,000 USDT in Xiaoyu’s account. After returning the 900 USDT from the exchange, Xiaoyu’s profit transferred from this transaction will be 1,000 USDT.
If Xiaoyu only used his original 100U principal to trade, the profit would only be 100 USDT. So in this example, Xiaoyu used 10 times leverage and earned 10 times the profit by going long on Bitcoin.
However, when you actually trade contracts on an exchange, the exchange will not actually lend you money. Instead, it will use a similar calculation method to intuitively tell you the leverage multiple, expected profit or loss, making it easier for more investors to use it.
Why does contract trading result in loss of money or even liquidation?
In the above example, Xiaoyu made 10 times the profit by successfully predicting the rise of Bitcoin price. However, if the actual trend is contrary to the prediction, it will result in losses or even the loss of all principal.
Continuing with the above example, Xiaoyu has 100 USDT, and Xiaoyu believes that the price of Bitcoin will rise from 100 to 200 tomorrow, so he borrows 900 USDT from the exchange and buys 10 Bitcoins. Unfortunately, the price of Bitcoin starts to plummet, from 100 to 95, and the value of the 10 Bitcoins in Xiaoyu's hands is 950 USDT. If Xiaoyu chooses to stop loss at this time, after paying back the 900 loan, Xiaoyu's principal will only be 50 USDT, a loss of 50 USDT.
But if Xiaoyu refuses to stop loss, the price of Bitcoin will continue to fall, and it will fall to 90. At this time, the Bitcoin in Xiaoyu's hand is only worth 900 USDT. The exchange that lent money to Xiaoyu will think that it is not good. If the price drops further, Xiaoyu will not be able to repay the loan. So it will force liquidation of Xiaoyu's 10 Bitcoins and take back its own 900 USDT loan. At this time, Xiaoyu's account will be penniless, which is what we commonly call "explosion".
In short, when the trend of virtual currency is consistent with your expectations, contract trading can magnify your profits; but when the trend of virtual currency is contrary to your expectations, contract trading will also magnify your losses or even cause you to lose all your principal.
Advantages and disadvantages of contract trading
Advantages of contract trading
Amplify profits: Contract trading uses leverage multiples, allowing investors to control larger positions with less capital. This means that investors can achieve higher profits when market trends are in line with expectations. The use of leverage multiples provides capital efficiency and the potential for capital growth.
You can make money even when prices fall: Contract trading is not limited to long (buying), but also short (selling). This means that investors can take advantage of the market's downward trend to realize profits. Shorting allows investors to sell contracts when they predict a market fall, and then buy them back at a lower price to make a profit.
Supports advanced operations such as hedging: Some trading experts or institutions will open short contracts with low multiples to hedge risks while buying a large amount of virtual currency spot. If the currency price rises in the future, the profit of the spot can cover the loss of the short contract; if the currency price falls, the profit of the short contract can cover the loss of holding the spot
Disadvantages of Contract Trading
Risk of liquidation: Contract trading has a high degree of leverage, which also means that the potential loss is increased. If the market trend is contrary to expectations, investors may face significant losses or even liquidation risks.
Market knowledge required: Successful contract trading requires investors to have good market knowledge and analytical skills. For investors who lack relevant knowledge and experience, contract trading may bring greater risks
Classification of contract transactions
According to the delivery time of the contract, contract transactions can be divided into delivery contracts and perpetual contracts.
According to the contract pricing unit, contract transactions can be divided into U-based contracts and currency-based contracts.
The following is a detailed introduction
Delivery Contract
A delivery contract is a contract with a clear expiration date, also known as a futures contract. In a delivery contract, investors agree to deliver a specified amount of assets on a specific date in the future. The delivery date is generally determined in advance, and on that date, the contract holder must fulfill the delivery obligations according to the contract.
Delivery refers to the liquidation of loans held by investors. Regardless of whether you make a loss or a profit, the system will uniformly close and settle positions at the agreed time.
In the early days of cryptocurrency contract trading around 2017, most cryptocurrency exchanges only provided delivery contract functions. They were divided into weekly contracts, monthly contracts, and quarterly contracts, which were delivered on Friday afternoons, at the end of each month, and at the end of each quarter. Later, after BitMex launched perpetual contracts and achieved great success, perpetual contracts gradually became the mainstream product of cryptocurrency contract trading.
Perpetual Contract
A perpetual contract is a contract without an expiration date, also known as a perpetual forward contract. In a perpetual contract, investors can hold the contract indefinitely and decide when to close the position. This allows investors to trade more flexibly and without having to worry about the expiration date.
Unlike delivery contracts, perpetual contracts introduce funding rates to maintain price stability. You can simply understand the funding rate as the interest you have to pay to borrow money from the exchange to open and close.
Currently, perpetual contracts are the mainstream product for virtual currency contract trading. Taking the Bitcoin contract of Wei’an Exchange as an example, the trading volume of Bitcoin perpetual contracts is more than 200 times that of quarterly delivery contracts.
U-standard contract
U-based contracts are contracts that use a legal currency stablecoin (usually USDT) as the unit of account. In a U-based contract, the value of the contract is calculated in US dollars, for example, each contract represents a certain amount of US dollar value. This form of contract allows investors to more intuitively evaluate the value and risk of the contract, and directly use USDT to participate in the virtual currency market, without having to actually buy the currency and face the risk of currency price decline, which is particularly suitable for contract novices.
USDT is the most commonly used currency for U-denominated contracts. Recently, some exchanges have launched contracts denominated in USDC, but the trading depth is far less than that of USDT contracts. Taking the Bitcoin contract of Bybit Exchange as an example, the trading volume of BTCUSDT perpetual contract is 200 times that of BTCUSDC perpetual contract.
Currency-based contracts
Coin-based contracts are contracts that use cryptocurrency as the unit of account. In a coin-based contract, the value of the contract is calculated in cryptocurrency, for example, each contract represents a certain amount of Bitcoin or other cryptocurrency. This form of contract allows investors to directly use virtual currency to participate in the market without having to buy the currency into a stable currency and miss the opportunity for the currency price to rise.
Currency-based contracts are also called inverse contracts in some exchanges.
U-based contracts vs coin-based contracts
Spot Trading vs. Contract Trading
How to avoid margin call?
Control leverage: The possibility of liquidation is directly related to your leverage. The higher the leverage, the easier it is to liquidate. Simply put, when you open a 10x leverage, you will be liquidated if the price fluctuates 10% in the opposite direction; when you open a 100x contract, you will be liquidated if the price fluctuates 1%.
Set stop loss: Setting a stop loss price is an effective risk management tool. It can automatically settle and lock in losses after the contract loss reaches a certain level, avoiding further losses or even liquidation and loss of all principal.
