What is Contract Trading?
Contract trading is a derivative trading method in the cryptocurrency market that allows investors to participate in cryptocurrency trading through long positions (buying), short positions (selling), and leverage. This enables investors to amplify profits when prices rise and profit even when prices fall. Leverage allows investors to participate in larger market movements with relatively small capital.
Due to the design of contract trading rules, the price of cryptocurrencies in contract trading may differ from spot trading prices, which is a normal phenomenon. In cases of extreme price fluctuations, the difference can be significant, so participants must carefully assess risks when engaging in contract trading.
How Does Contract Trading Work?
The fundamental logic of contract trading is that it allows investors to borrow fiat or cryptocurrency and trade digital assets at a specific price at a future date.
For example:
Jack has 100 USDT, and Fish believes that Bitcoin’s price will rise from 100 to 200 tomorrow. At this point, Jack can borrow 900 USDT from the exchange, then use 1,000 USDT to buy 10 BTC. When the price rises to 200 the next day, Jack sells them.
After selling, Jack’s account will have 2,000 USDT. After repaying the 900 USDT borrowed from the exchange, Jack’s profit from this trade is 1,000 USDT.
If Jack had only used his original 100 USDT, his profit would have been only 100 USDT. In this case, Jack used 10x leverage, which enabled him to earn 10 times the profit by going long on Bitcoin.
However, when engaging in actual contract trading on an exchange, the platform does not actually lend money to traders. Instead, it uses similar calculations to intuitively show leverage multiples, expected profits, or losses, making it easier for investors to participate.
Why Can Contract Trading Lead to Losses or Liquidation?
In the above example, Fish made a 10x profit by correctly predicting Bitcoin’s price increase. However, if the market moves opposite to expectations, it can result in losses or even a complete loss of capital.
Continuing the example:
Jack has 100 USDT and believes Bitcoin’s price will rise from 100 to 200 tomorrow. So, he borrows 900 USDT and buys 10 BTC.
However, Bitcoin’s price starts dropping sharply, falling from 100 to 95. At this point, Jack’s 10 BTC is worth only 950 USDT. If Jack chooses to cut losses at this stage and repays the 900 USDT loan, he is left with only 50 USDT, losing 50 USDT.
If Jack refuses to stop the loss and Bitcoin continues falling to 90, his 10 BTC is now worth only 900 USDT. At this point, the exchange notices that Jack can no longer cover the borrowed amount. To prevent further losses, the exchange forcefully liquidates Jack’s position, taking back its 900 USDT loan.
As a result, Jack’s account balance becomes zero, which is commonly known as liquidation.
In summary:
• If the market moves in your favor, contract trading amplifies your profits.
• If the market moves against you, contract trading magnifies your losses and can even result in complete loss of capital.
Pros and Cons of Contract Trading
Advantages of Contract Trading
Amplifies Profits: Contract trading allows investors to use leverage, controlling larger positions with less capital. When the market moves as expected, investors can achieve significantly higher profits. Leverage provides capital efficiency and growth potential.
Ability to Profit from Price Drops: Contract trading is not limited to long positions (buying). Investors can also short-sell (sell first, buy later) and profit when prices fall. By shorting, investors sell contracts at a high price and buy them back later at a lower price, making a profit.
Supports Hedging and Advanced Strategies: Some experienced traders or institutions use contract trading for hedging. For example, if an investor holds a large amount of spot cryptocurrency, they can open low-leverage short positions as a hedge.
• If prices rise, the spot holdings generate profits, covering the losses from short contracts.
• If prices fall, the profits from short contracts offset the losses from holding spot assets.
Disadvantages of Contract Trading
Risk of Liquidation: Contract trading involves high leverage, which also means higher potential losses. If the market moves in the opposite direction, investors can face significant losses or even liquidation.
Requires Market Knowledge: Successfully trading contracts requires a strong understanding of the market and analysis skills. Investors without adequate knowledge and experience may face higher risks in contract trading.
Types of Contract Trading
Contract trading can be categorized based on different criteria:
1. By Settlement Time:
• Delivery Contracts
• Perpetual Contracts
2. By Pricing Unit:
• USDT-Margined Contracts
• Coin-Margined Contracts
Below is a detailed introduction to each type.
Delivery Contracts
A Delivery Contract is a type of contract with a specified expiration date, also known as a futures contract. In a delivery contract, investors agree to deliver a predetermined quantity of assets on a future settlement date. The delivery date is fixed in advance, and on that date, contract holders must fulfill their settlement obligations as specified in the contract.
Settlement refers to the process of liquidating the investor’s borrowed assets. Regardless of whether the investor has made a profit or a loss, the system will automatically close positions and settle accounts at the scheduled time.
In the early stages of cryptocurrency contract trading, around 2017, most exchanges only provided delivery contracts, categorized as:
• Weekly Contracts (settled every Friday afternoon)
• Monthly Contracts (settled at the end of each month)
• Quarterly Contracts (settled at the end of each quarter)
Later, when BitMEX introduced Perpetual Contracts and achieved great success, perpetual contracts gradually became the dominant product in cryptocurrency contract trading.
Perpetual Contracts
A Perpetual Contract is a type of contract without an expiration date, also known as a perpetual futures contract. In a perpetual contract, investors can hold positions indefinitely and decide when to close them. This provides traders with more flexibility as they do not need to worry about contract expiration dates.
Unlike delivery contracts, perpetual contracts use a funding rate mechanism to maintain price stability. Simply put, the funding rate can be understood as the interest cost for borrowing funds to open a position.
Currently, perpetual contracts are the mainstream product in cryptocurrency contract trading. For example, in the Binance exchange, the trading volume of Bitcoin perpetual contracts is more than 200 times that of quarterly delivery contracts.
USDT-Margined Contracts
A USDT-Margined Contract is a contract priced in fiat-backed stablecoins, usually USDT (Tether). In USDT-margined contracts, the contract’s value is calculated in US dollars, meaning that each contract represents a fixed USD equivalent value.
This type of contract allows investors to:
• Easily assess contract value and risk in USD terms.
• Trade using USDT without needing to buy actual cryptocurrencies, avoiding the risk of cryptocurrency price depreciation.
• Be beginner-friendly, making it a suitable choice for new contract traders.
USDT is the most commonly used stablecoin in USDT-margined contracts, though some exchanges also offer contracts denominated in USDC. However, USDT contracts have significantly deeper liquidity. For instance, on Bybit Exchange, the trading volume of BTC/USDT perpetual contracts is 200 times greater than that of BTC/USDC perpetual contracts.
Coin-Margined Contracts
A Coin-Margined Contract is a contract priced in cryptocurrency rather than fiat or stablecoins. In these contracts, the contract’s value is denominated in Bitcoin or other cryptocurrencies, meaning that each contract represents a fixed amount of crypto assets.
This type of contract allows investors to:
• Trade directly using cryptocurrencies without needing to convert them into stablecoins.
• Benefit from potential price appreciation of cryptocurrencies while participating in contract trading.
On some exchanges, coin-margined contracts are also referred to as Inverse Contracts.
U-based Contract vs Coin-based Contract
| Difference | U-based Contract | Coin-based Contract |
| Pricing Unit | Stable fiat currency, usually USD-pegged stablecoins such as USDT, USDC, etc. | Cryptocurrency such as BTC, ETH, ETC, etc. |
| Contract Value | Calculated in fiat currency, each contract represents a certain USD value. | Calculated in cryptocurrency, each contract represents a certain amount of Bitcoin or other cryptocurrencies. |
| Market Relevance | Allows for a more intuitive evaluation of contract value and risk. | More aligned with the characteristics and trends of the blockchain industry. |
Spot Trading vs Contract Trading
| Difference | Spot Trading | Contract Trading |
| Trading Object | Immediate trading of actual assets or cryptocurrencies | Trading based on contracts of assets or cryptocurrencies |
| Holding Period | No specific expiration date | Contract settlement has a specific expiration date |
| Leverage Effect | No leverage effect | Leverage can be used |
| Profit Method | Profit only when cryptocurrency prices rise | Profit can be made from both rising and falling cryptocurrency prices |
| Risk Management | Relatively straightforward and simple | Can use complex risk management tools such as stop-loss and take-profit orders |
How to Avoid Liquidation?
• Control Leverage Ratio: The possibility of liquidation is directly related to your leverage ratio. The higher the leverage, the easier it is to get liquidated. Simply put, if you use 10x leverage, a 10% adverse price movement will result in liquidation; if you use 100x leverage, just a 1% price movement in the opposite direction will cause liquidation.
• Set Stop-Loss Orders: Setting a stop-loss price is an effective risk management tool. It automatically closes a position once losses reach a certain threshold, preventing further losses or total liquidation of your principal.
• Friendly Reminder: Coin-margined contracts and delivery contracts are currently under development. Stay tuned for upcoming releases!
What is the Correct English Term for Contract Trading?
Here are some common English terms for contract trading:
• Futures Contract: Can also be referred to as Contract or Futures. However, be careful not to drop the “s” and write Future instead. Future refers to time ahead, whereas Futures refers to futures contracts in financial trading.
• Swap: Commonly used in Western exchanges and foreign exchange (Forex) markets. In Forex trading, Swap and Futures have distinct meanings, but in cryptocurrency contract trading, these terms are often used interchangeably.
• Derivative: Means derivative products, but using this term alone to refer to contract trading is inaccurate. This is because derivatives also include Options, ETFs, Indices, and other financial instruments. If you want to be precise when referring to contract trading, do not use “Derivative” as a standalone term.