In the fast-changing world of cryptocurrency, many people are getting into trading to leverage opportunities in digital assets.
Two primary trading methods in the cryptocurrency market, namely spot and futures trading, offer distinct strategies and opportunities. Spot trading involves buying and selling cryptocurrencies at the current market price. In contrast, futures trading is buying and selling contracts representing a cryptocurrency’s future price. But which one suits you better?
Whether you’re a seasoned trader or a newcomer to the crypto space, it’s crucial to understand the fundamental distinctions between the spot and futures markets to select the most suitable trading method for you and thereby make notable profits.
Spot Trading In Crypto
Before you learn the difference between the spot and future markets, let’s first understand the concept of spot trading.
Crypto spot trading involves the purchase and sale of cryptocurrencies at their current market price. It is the simplest and most common form of cryptocurrency trading and is typically done on centralised exchanges.
When you spot trade a cryptocurrency, you buy or sell it outright. Simply put, you take immediate delivery of the cryptocurrency if you are buying, and you deliver the cryptocurrency if you are selling. Such trades are settled in real-time, and you can withdraw your cryptocurrency from the exchange after completing the transaction.
How Spot Trading Works?
The process of crypto spot trading is straightforward. To spot trade a cryptocurrency, you must create an account on a centralised cryptocurrency exchange such as Binance, Coinbase Exchange, or KuCoin. Once your account is verified, you need to deposit fiat currency or cryptocurrency into it.
After you have the required funds, you can place a spot order to buy or sell a cryptocurrency. You can buy or sell at the current market price or set a limit order to buy or sell at a specific price.
If you place a market order, your order will be executed immediately at the best available price. On the other hand, if you place a limit order, your order will only be executed if the market price matches your specified price.
Once your spot order is executed, you will own the cryptocurrency if you bought it or have fiat currency in your account if you sold it. If you buy crypto, you can hold your cryptocurrency long-term, sell it for a profit, or use it to purchase other goods and services.
Here is an example of how crypto spot trading works:
- You create an account on a centralised cryptocurrency exchange and deposit fiat currency into your account.
- You decide to buy Bitcoin (BTC) at the current market price. You place a market order for 1 BTC.
- Your order is executed immediately, and you now own 1 BTC.
- You decide to sell your 1 BTC for a profit. You place a market order to sell 1 BTC.
- Your order is executed immediately, and your account will be credited with fiat currency.
Characteristics Of Spot Trading
Here are some of the critical characteristics of crypto spot trading:
- Immediate settlement: Spot trades are settled immediately, meaning that the buyer receives the cryptocurrency they purchased, and the seller receives the fiat currency or cryptocurrency they sold it for immediately after the trade is executed.
- Variety of trading pairs: Spot traders have access to various trading pairs, including pairings between different cryptocurrencies and between cryptocurrencies and fiat currencies.
- Liquidity: Spot markets are typically very liquid, meaning there is a high volume of trading activity. This makes it easy to enter and exit positions quickly and at a fair price.
- Volatility: Crypto spot markets can be very volatile, meaning prices fluctuate quickly. This can make spot trading risky, but it also offers the potential for high profits.
Benefits Of Spot Trading In Crypto
Here are some of the benefits of crypto spot trading:
- Simplicity: Spot trading is relatively straightforward, making it a good option for beginners.
- Ownership: You own the crypto assets you purchase, giving you more control over your investments.
- Flexibility: You can buy and sell crypto assets whenever you want, as long as the tokens have a market.
- Variety: You can select amongst the many crypto assets available to trade on spot markets.
Drawbacks Of Spot Trading In Crypto
Here are some of the drawbacks of crypto spot trading:
- Volatility: The crypto market is very volatile, meaning prices fluctuate wildly. Hence, making profitable trades and avoiding debilitating losses can be challenging.
- Liquidity: Not all crypto assets are liquid, meaning there may not be a lot of buyers or sellers for them. Therefore, it may not be easy to execute trades quickly and efficiently.
- Fees: Cryptocurrency exchanges charge fees for trading. These fees can vary depending on the exchange and the type of trade being executed.
Now that you have understood the concept of spot trading in cryptocurrency, let’s move to futures trading in crypto.
Futures Trading In Crypto
Crypto futures trading is a type of derivative trading involving buying or selling contracts representing an agreement to trade a cryptocurrency at a predetermined price on a future date. Unlike spot trading, you do not own the underlying cryptocurrency but have a contract to buy or sell it at a specific price on a particular date.
How Does Futures Trading Work?
To trade crypto futures, you need to open an account with an exchange that offers this type of trading. Once you have an account, you can deposit funds and start trading.
To buy a crypto futures contract, you agree to purchase the underlying cryptocurrency at a predetermined price on a future date. To sell a crypto futures contract, you agree to sell the underlying cryptocurrency at a predetermined price on a future date.
If you buy a crypto futures contract and the price of the underlying cryptocurrency goes up, you will make a profit. Alternatively, you will lose money if you buy a crypto futures contract and the underlying cryptocurrency costs decrease.
The same is true if you sell a crypto futures contract. If you sell a crypto futures contract and the price of the underlying cryptocurrency goes down, you will make a profit. You will lose money if you sell a crypto futures contract, and the underlying cryptocurrency costs increase.
Trading in crypto futures can be risky, as the market is highly volatile. However, it can also be very profitable if you succeed in your trades.
Here is an example of how crypto futures trading works:
- Trader A buys a Bitcoin futures contract for $10,000, with a settlement date of one month.
- Trader B sells a Bitcoin futures contract for $10,000, with a settlement date of one month.
If Bitcoin costs above $10,000 on the settlement date, Trader A will make a profit, and Trader B will lose money.
If the price of Bitcoin is below $10,000 on the settlement date, Trader A will lose money, and Trader B will make a profit.
Characteristics Of Futures Trading
Here are some of the critical characteristics of crypto futures trading:
- Standardised contracts: Crypto futures contracts are standardised regarding their underlying asset, quantity, quality, delivery date, and trading rules. This makes it easy to trade contracts on different exchanges.
- Shorting: Crypto futures trading allows you to short cryptocurrencies, meaning you can profit from falling prices, which is impossible with spot trading.
- Liquid markets: Crypto futures markets are typically very liquid, meaning there is an ease with which buyers and sellers can find each other and execute trades at fair prices. This makes it relatively easy to execute trades quickly and efficiently.
Benefits Of Futures Trading In Crypto
Here are some of the benefits of crypto futures trading:
- Speculation: Crypto futures trading allows you to speculate on the future price of cryptocurrencies. This can be a profitable strategy for you if you can accurately predict future price movements.
- Hedging: Crypto futures trading can be used to hedge against risk. For example, if you own Bitcoin, you may buy Bitcoin futures contracts to protect yourself against a decline in its price.
- Leverage: Crypto futures trading offers leverage, which can amplify profits and losses. It can make crypto futures trading a very profitable strategy for experienced traders.
Drawbacks Of Futures Trading In Crypto
Here are some of the drawbacks of crypto futures trading:
- Complexity: Crypto futures trading is a complex form and is unsuitable for all investors. It is essential to understand the risks involved before trading crypto futures.
- Volatility: The crypto market is very volatile, meaning prices fluctuate wildly. This can make it challenging to make profitable trades and lead to losses.
Comparison Of Crypto Spot Trading And Crypto Futures Trading
Now that you have understood the concept of spot and futures trading, let’s first check the similarities between these two methods, followed by the spot vs. futures pointers.
Spot Vs. Futures: Similarities
Here are the similarities between crypto futures trading and crypto spot trading:
Both Can Be Used To Profit From Rising Or Falling Prices
You can use spot and futures trading to profit from rising or falling prices of cryptocurrencies. If you believe that the price of a cryptocurrency will go up, you can buy it and then sell it later when the price has increased.
Conversely, if you believe that the price of a cryptocurrency will go down, you can sell it short and then repurchase it later when the price has decreased.
Both Require A Brokerage Account
You must open a trading account with a cryptocurrency exchange to trade spot and futures contracts.
Both Are Subject To Market Volatility
The cryptocurrency market is highly volatile, meaning prices fluctuate wildly. This is true for spot and futures trading, and it can lead to significant losses if you are not careful.
Futures Vs. Spot: Differences
The key differences between spot vs futures trading are as follows:
Leverage uses borrowed funds to increase one’s trading position beyond what would be available from one’s cash balance alone. Leverage allows you to amplify your profits but also your losses.
In crypto spot trading, leverage is unavailable, meaning you can only buy or sell cryptocurrencies with your funds. However, in crypto futures trading, leverage is widely used. You can open positions much larger than your account balance by depositing a fraction of the contract value as a margin.
For example, with 10x leverage, you can open a 1 BTC futures position with only 0.1 BTC as a margin.
Flexibility refers to the ability to trade in different market conditions and directions. In crypto spot trading, flexibility is limited, as you can only profit from rising prices by buying low and selling high.
On the other hand, flexibility is higher in futures trading, as you can profit from rising and falling prices by going long or short. Going long means buying a futures contract in anticipation of a price increase, while going short means selling a futures contract in anticipation of a price decrease.
Crypto futures trading also allows you to hedge your spot positions against unexpected risks and volatility.
The risk involved refers to the potential for losing money in trading. In crypto spot trading, the risk involved is relatively low, as you only lose money if the price of the cryptocurrency you own goes down. However, you also have to bear the risk of storing and securing your cryptocurrencies, which may be vulnerable to hacking or theft.
In crypto futures trading, the risk involved is relatively high, as you can lose more than your initial margin if the price moves against your position. They must also consider factors such as liquidation, funding rate, expiry date, and rollover cost that may affect the profitability.
If you buy cryptocurrencies on the spot market, you own them and get all the benefits like forks, staking, and airdrops. If a cryptocurrency forks, you get the new coins from the new blockchain branch.
For instance, in 2017, if you had Bitcoin (BTC), you also got Bitcoin Cash (BCH). But you don’t get these extra benefits if you’re a futures trader because you only own the contracts, not the actual cryptocurrencies.
Spot Price Vs. Futures Price
A spot price is the current market price of an asset for immediate delivery. Futures price is the agreed-upon price of an asset for delivery at a future date. Supply and demand in their respective markets determine spot prices and futures prices.
The difference between the spot and futures prices is called the futures premium or discount. A positive premium means that the futures price is higher than the spot price; a negative discount means that the futures price is lower than the spot price.
The futures premium or discount may change depending on interest rates, dividends, storage costs, and market expectations.
But how can you decide which trading method is best suited for you?
Considerations For Choosing Between Spot Trading And Futures Trading
Below mentioned are a few points, but you mention more if you found any while researching the topic:
1. Risk Tolerance
Spot trading is less risky than futures trading. Spot traders do not use leverage and, therefore, have less exposure to price volatility. On the other hand, futures traders can use leverage to amplify their profits, which also amplifies their losses.
Spot trading may be a better option if you have a low-risk tolerance. If you have a higher risk tolerance, you can tolerate the risks of futures trading.
2. Trading Goals
What are your trading goals? Are you looking to invest in crypto for the long or short term? Spot trading may be a better option if you are looking to invest for the long term. Spot traders have more flexibility and can buy and sell crypto anytime.
If you want to speculate on short-term price movements, futures trading may be a better option. Futures traders can use leverage to amplify their profits, but they can also lose a lot of money quickly if the market moves against them.
3. Capital Requirements
Spot trading requires less capital than futures trading. This is because spot traders do not need to pay margin. Futures traders, on the other hand, must pay margin to open and maintain a position. The margin requirement varies depending on the exchange and the underlying asset.
If you have limited capital, spot trading may be a better option. If you have more capital, you can trade futures contracts.
4. Trading Experience
Futures trading is a complex subject, and it is crucial to understand how it works before you start trading. If you are new to crypto trading, it is generally recommended to start with spot trading.
Once you gain more experience, consider futures trading. However, it is crucial to understand the risks involved and to use risk management techniques.
The choice between crypto spot trading and crypto futures trading ultimately comes down to your goals, risk tolerance, and market expertise. Understanding the critical differences between these two methods is crucial. It empowers you to make informed decisions, tailor your trading strategy to your objectives, and manage your risk effectively.
Moreover, both spot and futures trading can have tax implications based on your national jurisdiction. Additionally, manual calculation of such taxes can be laborious. This is where you can use KoinX, an automated crypto tax calculating platform, which gives you accurate tax reports on your crypto transactions. So why wait? Sign up on KoinX today.
Frequently Asked Questions
Which Is More Profitable, Spot Trading Or Futures Trading?
Both spot and futures trading can be profitable, but it depends on the skill and experience of the trader. Futures traders have the potential to generate higher profits, but they are also exposed to greater risk.
What Are The Risks Involved In Trading?
All types of trading involve risk, including the risk of loss. Spot traders are exposed to the risk of loss if the price of an asset falls after they purchase it. Futures traders are exposed to the risk of high losses if the market moves against them.
How Is Taxation Different For Spot And Futures Trading?
Taxation can vary by location, but both trading methods are generally subject to capital gains tax.