In general, a spot market is where the commodities are traded on the spot with immediate delivery. While a futures market, as the name suggests, settles the delivery of commodities and futures contracts on a specific future date.
Spot and futures markets are terms used in the financial market, like stocks or forex. But did you know they’re also the fundamentals to shape the crypto market?
Crypto market has had its fair share of ups and downs, in particular, the significant plunge of Bitcoin (BTC) prices from the neighborhood of $20,000 to $3,000 after the rally in 2017. Then goes the ever-changing regulations towards the adoption of Bitcoin. Until the recent BTC’s bull that sky-rocketed to its all-time high around $61,000. That is still shocking to the majority of Bitcoin spot and futures market traders.
So why is understanding the difference between spot trading and futures trading so important?
Let’s find out!
What Is a Spot Market?
Spot market is referred to as the cash market because of the way payments are immediately processed. In other words, the contract between the buyer and seller will be performed on the spot at the prevailing price with a determined quantity.
Let’s say Harry (buyer) wants to buy BTC from fiat (USD) in the spot market — he would need to look for a seller who’s in search of USD to perform the exchange. So, Harry could go to a crypto exchange spot market to look for the BTC/USD trading pair by setting a limit order at a predetermined price and quantity for the execution.
In any case a buyer and seller make an equivalent offer in the spot market, the trades will be executed immediately.
The Characteristics of Spot Market
The crypto market operates 24/7, which means you can buy and sell crypto any time and any day. All transactions are settled with a ruling price known as spot rate, aka spot price in the spot market. Anyone who’s holding spot market contracts can hold and find a better deal if they are not immediately satisfied with the current prices. But there should be an active demand and supply for traders to execute to trade.
The Types of Spot Market
There are two main spot markets; over-the-counter (OTC) and market exchanges.
OTC in crypto trading is when you can trade in a decentralized market without an intermediary. There will be no need for a broker or any other central exchange involved in the process.
The OTC market mainly deals with immense volumes with seeming opacity outside the public eye’s periphery. That’s because the trades in the OTC markets are usually private. On the other hand, the execution process is relatively straightforward. Whenever two parties agree on a price, trading volume, and transfer method, a trade can be executed directly without the involvement of an intermediary.
Market exchanges is a regulated market where you can place orders through a trading platform or broker. Crypto prices will be shown immediately through real-time quotes. This type of spot market follows exchange hours.
On the other hand, exchanges act as intermediaries for buyers and sellers to bid and ask for an asset. When there’s a match for the bid and an asking price, the exchange will facilitate the trade.
When comparing it with the futures market, the spot market would be ideal for you if you’re looking for a long-term investment. On the contrary, if you intend to leverage or hedge your trade, the futures market should best suit you.
What Is the Futures Market?
A futures market is where you make a contract with another party to agree on an asset’s price for a date in the future. This speculation is placed on a specific day, but the transaction is not on the spot. So your crypto will only be bought or sold at a specific set price and date that have been agreed upon in a futures contract.
Unlike the spot market, you’re trading contracts in the futures market without actually owning an underlying asset. In fact, futures contracts are made in an attempt to avoid market volatility. For example, when you’re trading a BTCUSD contract, you’re not actually buying or selling BTC, but rather trading on the presumed value of BTC.
In other words, you are betting on the price movement of BTC that is parallel to the value of the contract without owning the asset.
Characteristics of Futures Market
Volatility in crypto trading is inevitable, and it has been a concern for many traders. Still, the price swings offer trading opportunities for traders to predict the price movements.
The derivatives products are a form of a futures contract. Prior to signing the agreement, buyers and sellers must predetermine the price and date. And hedging is common to a futures contract.
For example, Bybit offers x100 leverage to allow traders hedge capital to fund the contract without the need to fund a position upfront. What Bybit offers is to provide traders with a more substantial amount of capital to open a long position with the anticipation for the price to go up or short for the asset’s price to drop.
Understanding The Key Differences
Understanding key differences in the spot vs. futures market is vital to a successful trade. Once you understand their characteristics, you can easily identify each of these financial opportunities’ advantages and limitations.
Here are some highlights:
Spot and Futures Prices
Let’s say you place a trade in the spot market, the transaction will be made right away. However, in the futures market, your asset has a locked price to be traded in the future based on the agreed terms.
Spot price fluctuations are based on the volatility of an asset. For example, Bitcoin’s spot price can swing up or down significantly within minutes and hours. So when Tesla announced its massive investment in Bitcoin, the market rallied in response.
A common assumption is the futures prices are often higher than spot prices. But that is not always the case.
Truth is, futures contracts involve many factors before you can start speculating an asset’s price and eventually agreeing on a trading price. Still, you should decide whether to bet that the futures price will benefit them or otherwise based on the real-world perception of volatility and price arbitrage.
Date of Delivery
The delivery date is the expiration date of a futures contract. To simplify it, it is the futures contract’s final date where the specified price and the crypto asset must be delivered. When the delivery date arrives, a contract holder must receive his or her underlying asset.
However, this date differs from one contract to another. Some traders or investors can set a specific day, while others might decide on a month. Suppose you have agreed on the date of delivery in a month, the trade must be transacted a few days before the end of that particular month.
Also, each delivery date has a unique code which is made up of numbers and letters. The exchange will act as an intermediary, but the last two symbols will be the month and the year, in that order. However, depending on the exchange, the last two symbols can be the month and date. For example, Bybit’s inverse futures contract is BTCUSD0625, settling on June 25, 2021.
But, if you decide to trade a forward contract instead of a futures contract, you are trading or investing through an over-the-counter spot market. Forward contracts allow the date to be adjusted when both the buyer and the seller agree to do so.
Margin and Leverage
If you want to use leverage in a spot market, you must first buy crypto coins and pay a transaction fee according to the exchange. It is, however, essential to note that their lending is not greatly funded. That means the leverage offered is usually not too high because their loaning balance isn’t either.
On the other hand, futures markets have sufficient funds in their lending pools, which means they can offer higher leverage.
When you use leverage on a futures contract, you don’t need to pay the full amount of the contract. You can enter a specific percentage of the contract’s total value, which is known as the initial margin amount.
Note: Initial margin is the amount of collateral required to open a position for leverage trading.
This initial margin usually ranges between 3% to 12% of the total value of the contract. But it is highly different from one exchange to another. For example, Bybit allows traders to add or reduce their margin to a position under isolated margin mode. However, the flexibility is subject to change based on the conditions.
Whether you end up trading crypto with the spot market or futures contracts through market exchange, it is necessary to understand the risks. Every trader or investor’s goal is to minimize risk and maximize gains.
One of the situations you could see yourself in is counterparty risk. That means the other party does not meet the obligations. This could happen because the opposite party is either unable to meet the terms or is unwilling to reciprocate.
However, since futures contracts mean you are trading through an intermediary, it is less probable to encounter a counterparty risk because the value is based on the market rate.
On the other hand, forward contracts are not regulated by the market like futures. They are agreed upon according to the buyer and the seller. These contracts finalize when the crypto is exchanged, which means you will only know your profit and loss when the date comes around.
Parties Involved in a Trade
Other than you as an individual trader, is anyone else involved?
The answer is yes, and the relevance is significant.
Both spot markets and futures markets have two main parties involved in the transaction; a buyer and a seller. The spot market boasts with immediate transactions. So when the buyer’s and seller’s prices match, the trade will be executed.
As for the futures market, there is often an intermediary that is involved within the process.
Fees are always a concern when it comes to trading. That is because they can pile up and decrease your overall gains.
Spot market crypto trading usually charges a transaction fee that is set around 0.1% to 0.2%. There could also be transaction fees that depend on the trading volume of the total of buyers and sellers in the market.
Despite the trading fees, futures contracts usually have a settlement date too. When a settlement date is met, 100% of all the positions must be closed entirely. Therefore, when traders decide not to close their position manually, the system will automatically settle the position at the point of reaching the settlement date. And an outstanding position will be subject to a settlement fee.
– Market takers, who seek liquidity and take liquidity off the book immediately will be charged a trading fee.
– Market makers, who provide liquidity and increase the market depth of order books will receive a rebate.
For example, Bybit adopts the taker’s and maker’s fee structure (0.075% taker fees) and (-0.025% maker fees) for all perpetual contracts when the futures order is manually placed to open or close the positions.
So, is the futures market better than spot? That will depend on your needs and trading strategies.
Day trading may be better paired with the spot market, where you can instantly buy or sell regularly. But if you would rather speculate the crypto price, then future contracts could be a better option.
A clear understanding of the trading market and paired with controlled emotions yields the best results.