Many traders entering the cryptocurrency markets from traditional finance may view derivatives as a way to speculate on prices and hedge. When it comes to switches and tools, there are many options; However, traders should consider some important differences between cryptocurrencies and traditional futures before diving into this fast-growing market.

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Various tools
Traders entering cryptocurrencies from traditional markets will get used to fixed-expiration futures contracts. While fixed-term contracts can be found in the cryptocurrency markets, a large portion of cryptocurrency futures trading is conducted through perpetual contracts, also known as perpetual swaps. This futures contract option does not have a fixed expiration date, which means that a trader can hold an open position indefinitely.

Exchanges offering perpetual contracts use a mechanism known as a “funding rate” to periodically balance discrepancies between contract prices and spot prices. If the financing rate is positive, the perpetual contract price is higher than the spot rate – buyers pay short. Conversely, a negative funding rate means that shorter time frames pay off for a longer period.

In addition, traders who access cryptocurrencies through traditional financing can be used to transfer their positions to different exchanges. In contrast, cryptocurrency exchanges usually operate like walled gardens, which means that derivative contracts cannot be transferred between platforms.

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Regulated and unregulated trading platforms
Most cryptocurrency futures trading – from 85 to 90% – is not yet regulated. This situation stemmed primarily from the emergence of the crypto-futures market, while regulators continued to grapple with more fundamental questions about the legal status of digital assets. BitMEX paved the way for cryptocurrency futures trading using margin contracts and collateral. By doing so, the company avoided ramp regulations. Currently, there are about a dozen large trading platforms, but only a small part of them have achieved regulated status.

Both the Chicago Mercantile Exchange (CME) and Bakkt are regulated by the US Commodity Futures Trading Commission (CFTC). In Europe, Kraken Futures operates under a multilateral trading license issued by the Financial Conduct Authority in the United Kingdom. In Switzerland, Vontobel and Leonteq offer mini Bitcoin futures contracts through the SIX Swiss Exchange.

The regulatory situation may prevent traders in some countries from trading in unregulated arenas. This circumstance is especially true in the United States, where exchanges know that the CFTC is currently pursuing BitMEX for violations of anti-money laundering regulations and the Banking Secrecy Act.

However, US-regulated cryptocurrency futures platforms have expanded the range of their instruments beyond pure Bitcoin (BTC) futures, likely in response to increased demand. For example, the Chicago Mercantile Exchange recently surpassed Bitcoin futures and the ability to provide Ether (ETH) futures. In addition, Bakkt also offers monthly bitcoin futures and options.

Unregulated platforms offer futures and perpetual swaps on a wider range of altcoins, but only to traders in countries where they are allowed to operate. In any case, most of the liquidity remains concentrated in BTC and ETH futures, at least for the time being.

Operational effects
The different regulatory landscapes, along with how perpetual contracts are handled, lead to some practical differences between cryptocurrencies and traditional futures. Since there is no central counterparty clearing system, exchanges are subject to a high degree of risk, especially given that many of them have a strong influence of up to 125 times. Thus, the loss of positions is the same as when the maintenance margin is closed.

The exchange typically transfers the liquidation gains to an existing insurance fund to protect traders’ profits when the counterparty does not have enough margin to cover the transaction. The existence and relative health of the insurance fund is a critical factor when using unregulated exchange. Without a fund, or if the fund becomes too small to cover losses from liquidation, profitable traders risk having their positions automatically “shortened” by the exchange.

Another important operational consideration is drain disruption. Many unregulated platforms are notorious for server outages during periods of high volatility.

Source: CoinTelegraph