Spot vs. Perpetual Futures – Everything You Need to Know

Cryptocurrency trading has come a long way, and there are now many different paths available to traders that want to profit from price volatility. However, usually the most well-known and widely used methods of trading are Spot Trading and Perpetual Futures Trading. Spot trading is where a trader directly owns the asset they want to buy or sell, while with perpetual futures the trader is speculating on the price without any actual ownership of the underlying asset. This article will help beginners and experienced traders better understand the differences between these trading approaches. In this blog, we will look into how they work, highlight their differences, and help you make a better decision on which you would like to consider as a high performing potential strategy.

What Is Spot Trading?

Spot trading is the most efficient and commonly used form of cryptocurrency trading. In spot trading you buy or sell crypto at the current market price (often referred to as spot price), meaning as soon as a trader executes the trade, the ownership of the crypto asset transfers ownership in a matter of moments. After now owning a digital asset, the buyer may store, transfer or just hold it for later. Unlike derivatives or futures, spot trading does not leverage your trade. This allows traders to only trade with the actual amount defined in their wallet so they only risk the amount of currency trade for their crypto assets. Spot trading is also a popular method for long-term investors because they can build their crypto portfolio and benefit from potential past appreciation.

How Does Spot Trading Work?

Spot trading takes place on centralized exchanges (like Binance, Coinbase) and decentralized exchanges (like Uniswap). A trader places a buy or sell order at the current market price of the cryptocurrency being traded. Once the order matches, the trade is completed at that quantity instantly. For instance, if the price of Bitcoin is $40,000, and a trader buys 0.5 BTC, that trader now has that quantity of Bitcoin in their wallet right now. The transaction happen surprisingly fast! Spot markets may also utilize order types like market orders, limit orders, and stop orders, giving the trader flexibility on how to transact. 

In comparison to leveraged markets, the risk of spot trading is less; however, the profit (or loss) from that transaction will be equal to the appreciation (or depreciation) of the cryptocurrency in the spot market. Spot trading is simple and straightforward process to acquire true crypto assets without any additional complexity such as derivatives.

What Is Perpetual Futures?

Perpetual futures offer traders a way to speculate on the future price of cryptocurrencies, but they do not own the asset as in a spot transaction. Perpetual futures are unique because traditional futures contracts have an expiration date where traders must settle the contract; however, perpetual futures have no expiration date. This is a significant advantage for perpetual futures traders, as a trader can hold their position indefinitely until a margin requirement is met. If you are a short-term trader and want to benefit from both rising and falling markets, this is a unique advantage for perpetual futures traders. By utilizing leverage, traders can open even larger positions than they would normally.

How Does Perpetual Futures Work?

Perpetual futures allow traders to go long (buy) if they believe the asset's price is going up; or to go short (sell) if they believe the price will decrease. For example, a trader believes Ethereum will appreciate so they go long; conversely, if they believe Ethereum's price will drop, they would go short. The funding rate mechanism is applied to perpetual futures to keep the perpetual futures price close to the underlying spot price. If the futures price is higher than the spot, long traders pay the funding fee to short traders, and vice versa. Funding fees will incentivize equilibrium between both markets. Importantly, since perpetual futures allow for leverage, a trader with $1,000 can control a $10,000 position in the market. This would impact gains and losses in both directions. Therefore risk management is important when trading in the futures markets.

Spot vs. Perpetual Futures: Key Differences

Ownership
Spot traders have the real asset while perpetual futures traders speculate on price.

Leverage
Spot trading has no leverage; perpetual futures can utilize leverage for larger positions.

Timeframe
Spot is convenient for immediate and long-term trades; perpetual futures were developed for active and short-term traders.

Risk
Spot trading only risks your invested capital, while the risk of perpetual futures is higher due to the margin debt.

Use Case
Spot is for investors who want to build portfolios, while perpetual futures are for active traders wanting to profit in the short-term.

Pricing Mechanisms in Perpetual Futures vs. Spot Trading

Spot prices are set entirely by the market's supply and demand. Meanwhile, perpetual futures prices are designed through a funding rate to mimic the spot price. This self-adjusting mechanism allows for price stability but also brings potential funding costs or gains depending on a trader's long or short position. 

Pros and Cons of Spot vs. Perpetual Futures Trading

Spot Trading Pros: Simple process, transparent, actual asset ownership, less risky.
Spot Trading Cons: No leverage, profit potential is limited in sideways markets.
Perpetual Futures Pros: Greater potential for profits from leverage, no expiry date, potential profits from increased price and declining price.
Perpetual Futures Cons: Leverage creates a high risk of loss, complicated mechanics, funding fees can impact profitability.

Factors to Consider When Choosing Between Spot and Futures Trading

Traders must consider their risk profile, investment timeframe, and market understanding when choosing between spot and perpetual futures. Spot trading may suit investors that want to hold an asset over the long term for capital gains in for their portfolio convention. Perpetual futures may be more suited to experienced traders with the appetite to use leverage and actively monitor the market. Ultimately choosing one type or the other comes down to the trader's personal aspirations, wealth building over time, or seeking short term speculative gains. Often traders will use a both/ and approach to trade the risks and methodologies.

Wrapping Up

Spot and perpetual futures are two powerful trading mechanisms that target two types of investors. Spot trading is simple and allows ownership of the asset while perpetual futures trading can be a way to speculate and make moves in either direction of the market. It's important to understand how they work as well as the risks and benefits to determine which path is right for you.

If you're a business building sophisticated trading platforms, partnering with a Crypto Exchange Development Company like Osiz can provide breadth to your crypto initiative. Osiz has extensive experience in building spot and futures trading software and can help you develop secure, scalable, and user-friendly platforms that align with market needs.

Whether you are an advanced trader exploring various strategies or a new entrepreneur aiming to launch a public exchange, working with Osiz, a trusted Crypto Exchange Development Company, can set you up for long-term success in this constantly evolving market.