Unpacking Inverse Futures Contracts: Advantageous Tool or Risky Business?
Summary:
Inverse futures contracts are financial agreements that are primed to benefit from price decreases, unlike conventional futures. Used predominantly in cryptocurrency trading, these contracts are denominated in fiat currencies or stablecoins like the US dollar or Tether (USDT). Despite their advantages, including reinvesting earnings in long-term cryptocurrency holdings and offering leverage in bullish markets, these contracts involve risks such as counterparty defaults, liquidity problems, and susceptibility to market volatility. These contracts stand in contrast to linear futures contracts, where the settlement is conducted in stablecoins or the base cryptocurrency.
Inverse futures contracts are specialized financial tools typically utilized in the realm of cryptocurrency trading. This financial agreement obligates the contract seller to compensate the buyer for any discrepancies between the predetermined price and the actual one once the contract has matured. Contrary to traditional futures, sellers gain from price drops in these contracts. Regardless of which cryptocurrency underlies the transaction, inverse futures contracts base their values on fiat currencies such as the US dollar or stablecoins such as Tether (USDT). Profits and losses are inversely proportional to the fluctuations in the related cryptocurrency's price.
In terms of how inverse futures contracts function, think of it as a financial instrument that works in a counter-intuitive manner. When a broker initiates a long position on a BTC/USD inverse futures contract, they are effectively shorting the USD. The higher the price of Bitcoin, the more it increases compared to the dollar. To grasp the workings of inverse futures contracts better, consider the following illustration where the profit earned from a BTC position using such contracts is determined. The position size is 1 Bitcoin, the entry price is $62,000, and the exit price is $69,000. This case would yield a profit of 0.00000164 BTC, which would be deposited in the trader's crypto wallet.
In comparison to linear futures contracts, where settlement happens in stablecoins such as USDT, inverse futures contracts settle in the base cryptocurrency, such as Bitcoin. Traders of both contracts utilize and profit in the same currency. Unlike inverse futures contracts, the margin and profit/loss with linear contracts are priced in the quote currency. Inverse futures contracts use the base currency for trading, but the profit/loss is earned in the quote currency.
The advantage of inverse contracts is that it lets traders directly reinvest earnings back into long-term cryptocurrency holdings. It also supplies leverage for profitable gains during bullish markets and works as a hedge, circumventing the need to convert holdings into stablecoins like USDT.
It's worth noting that dealing with inverse futures contracts has inherent risks including exposure to market volatility. Such contracts may be quite sensitive to market swings, affecting both profits and losses. Exchanges or trading platforms trading inverse futures contracts may pose another risk factor. If the exchange is unable to fulfill its financial obligations or goes bankrupt, such counterparty defaults could result in traders losing their money. Lastly, liquidity problems might arise, particularly in tense market conditions or when trading activity is low.
Published At
6/13/2024 11:30:00 AM
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