Periodically, we witness headlines announcing substantial Bitcoin (BTC) and cryptocurrency futures contracts liquidations exceeding $100 million. These occurrences often lead inexperienced investors and amateur analysts to attribute the cause to excessive leverage employed by retail traders.
Undoubtedly, a significant portion of these high-risk wagers can be attributed to gamblers, particularly when the liquidations predominantly affect retail-focused exchanges like Bybit and Binance. However, it is essential to recognize that not all futures liquidations stem from reckless leverage usage.
Professionals employing certain trading strategies may also experience liquidations during sudden, drastic price movements. Nevertheless, such instances do not necessarily equate to losses or indicate overreliance on leverage. Comparatively, platforms like the Chicago Mercantile Exchange (CME), OKX, and Deribit typically demonstrate lower liquidation ratios in contrast to retail-centric exchanges, suggesting the utilization of more sophisticated tactics by traders on these platforms.
Engaging in futures trading, particularly through perpetual contracts (inverse swaps), is relatively straightforward. Most cryptocurrency exchanges offer leverage of 20x or higher, with traders only required to make an initial margin deposit. Unlike traditional spot trading, futures contracts cannot be withdrawn from the exchange. While leveraged futures contracts are synthetic, they provide the opportunity to speculate on price declines.
While these derivative instruments offer distinct advantages and can enhance a trader’s performance, those who become overly confident often struggle to sustain profitability over the long term. To mitigate this risk, professional traders typically implement three distinct strategies aimed at maximizing profits without solely depending on directional trades.
Forced Liquidations on Low-Liquidity Pairs
Large investors (whales) utilize futures contracts to capitalize on volatile markets by targeting low-liquidity pairs. By opening highly leveraged positions, they anticipate forced liquidations resulting from inadequate margins. This triggers a domino effect, influencing the market in a favorable direction.
For example, in the case of a desired price decrease, substantial sell-offs are initiated, leading to further liquidations and subsequent price declines. Despite the initial appearance of losses, this cascading effect ultimately benefits the overall strategy. Implementing this tactic necessitates significant capital and multiple accounts while leveraging market dynamics to create a substantial impact.
Cash and Carry Trading
The cash and carry trading strategy involves purchasing an asset in the spot market and concurrently selling a futures contract on the same asset. This method locks in the price differential between spot and futures prices, with traders capitalizing on the convergence of these prices upon expiration of the futures contract.
This arbitrage strategy is low-risk and leverages pricing inefficiencies between markets, particularly effective in stable market conditions. It provides consistent returns regardless of overall market volatility, making it a preferred approach among risk-averse investors.
Funding Rate Arbitrage
Perpetual contracts charge a funding rate periodically to balance leverage demand between buyers and sellers. This rate fluctuates based on market dynamics, with buyers paying fees when the funding rate becomes positive due to increased leverage demand.
Market makers and arbitrage desks exploit these discrepancies by opening leveraged positions and hedging their risks through spot market transactions. This strategy, known as funding rate arbitrage, involves capitalizing on varying rates across markets, necessitating precise execution and continuous monitoring to optimize profits while managing risks effectively.
In essence, utilizing derivatives demands expertise, experience, and a substantial capital base to withstand market fluctuations. However, strategies like funding rate arbitrage can be lucrative even in less volatile markets, showcasing the prudent use of leverage to maximize profits in calmer market conditions.
Please note that this article is intended for general informational purposes and should not be construed as legal or investment advice. The opinions expressed herein are solely those of the author and do not necessarily reflect the views or opinions of Cointelegraph.