Virtual currency is a form of currency that exists digitally, unlike traditional paper money or coins, and resides in a blockchain database.
Blockchain is considered the core technology behind virtual currencies, consisting of a decentralized database made up of multiple nodes (computers).
Each transaction is recorded in a block, and these blocks are linked together using cryptographic techniques to form a chain, ensuring the security and immutability of transactions.
In addition, virtual currencies are designed with a decentralized philosophy, meaning they do not need to be managed by a central authority (such as banks or governments) but are maintained by a distributed network.
Currently, the largest market capitalization in the virtual currency market is 'Bitcoin', followed by 'Ethereum'.
What are virtual currency contracts?
Generally, when we mention virtual currency contracts, we are mostly referring to 'perpetual contracts'.
Perpetual contracts are an evolution of futures contracts from traditional finance, representing a new form of derivative trading in the cryptocurrency space.
The difference between the two is that virtual currency contracts do not have a fixed expiration date!
Thus, as long as traders have sufficient funds, they can hold contracts for extended periods and settle according to their trading plans without worrying about the impact of contract expiration on their trades.
In virtual currencies, the price of perpetual contracts can be considered an index, and this index typically closely aligns with the market's spot price.
In addition, the characteristic of virtual currency contracts is that investors can use 'leverage' to amplify their investment amounts according to their risk tolerance, enhancing capital efficiency.
What is the difference between virtual currency contracts and spot trading?
No holding of virtual currency spot
Compared to spot trading, virtual currency contracts only involve contract trading; investors do not actually hold virtual currencies but profit from price fluctuations through contracts.
Both long and short positions can be traded, providing profit opportunities regardless of price movements.
In typical spot trading, investors can only choose to go long (bullish). However, in contract trading, investors can choose to go long (bullish) or short (bearish) based on their market predictions.
Because of this, if investors understand how to use technical analysis, they can find suitable trading opportunities in different market cycles, whether in bear or bull markets, making profits both in rising and falling markets.
Available leverage amplifies capital
'Leverage' is a unique trading tool available only in the contract market. Through leverage, investors can participate in larger trades with relatively less capital, maximizing the utilization of existing funds and providing opportunities for greater returns.
In the virtual currency market, the leverage multiples available for contract trading can reach hundreds, depending on the rules of different exchanges!
However, it is essential to note that while leverage can amplify the utilization of capital, it also magnifies the risk of losses. Therefore, when using leverage in contract trading, it is crucial to implement risk management.
The operational principles of virtual currency contracts
Specifically, using virtual currency contract trading does not involve directly buying or selling cryptocurrencies, but rather agreeing to buy or sell an asset at a specified price at a future point in time.
Moreover, in the process of virtual currency contract trading, it does not involve immediate full settlement but rather adopts a 'margin mechanism'!
For example, in a perpetual contract, if you are bullish on the future price of Bitcoin, expecting it to rise from $10,000, and you want to invest the equivalent of $1,000 in stablecoins (USDT) as margin, while using 10x leverage for the contract trade.
The final position of this trade will be valued at $1,000 x 10 = $10,000 in the contract market.
Therefore, when the price of Bitcoin reaches $11,000 (a 10% increase), your profit will be the invested principal of 10% x 10x leverage = 100%, which is $100 x 10 = $1,000.
Conversely, if the price drops from $10,000 to $9,000 (a 10% decrease), the losses suffered will also be multiplied by 10.
What are the disadvantages and risks of virtual currency contracts?
Loss multiples amplified
During the process of virtual currency contract trading, effectively utilizing leverage can enhance capital efficiency and yield returns above expectations. However, the risks will also increase exponentially relative to the leverage used!
As leverage increases, even minor price fluctuations can lead to significant losses for investors; in extreme cases, it may even result in liquidation, wiping out all funds.
Therefore, when engaging in contract trading, remember to set the leverage multiple and stop-loss points to control risk.
Lower market regulation
Unlike traditional financial markets, the virtual currency market is relatively new. In the absence of comprehensive financial regulations and oversight, engaging in contract trading in the cryptocurrency market may entail various risks.
For instance, encountering a whale dumping, an exchange going bankrupt, or virtual currency fraud, etc.
Therefore, before making any investment trades in the cryptocurrency space, it is essential to conduct detailed research, assess one's own situation, and implement risk management to ensure expected returns in the virtual currency market.
Terminology related to virtual currency contracts
1. Leverage
Leverage is a unique tool in virtual currency contract trading that allows investors to participate in market trades with a multiple of their capital.
For example, if you want to open a position worth $1,000 with 10x leverage, the investor only needs to invest $100 (10% margin) to engage in a contract trade worth $1,000.
Although using leverage can increase potential returns, the risk also multiplies, so it is crucial to be cautious when investing.
2. Transaction Fees
Transaction fees are the costs incurred during virtual currency contract trading, including opening and closing fees.
The amount of transaction fees varies between exchanges, typically falling within 0.1%. Therefore, before investing, it is advisable to pay attention to the fee rates of major exchanges.
3. Funding Rate
The funding rate is a regulatory mechanism in virtual currency contracts that ensures the contract market price remains consistent with actual market prices.
As for the funding rate adjustment, most exchanges settle every 8 hours. If the funding rate is positive, it indicates that the contract market is primarily bullish, so investors choosing to go long need to pay an additional fee to short sellers, meaning the cost of going long increases.
Conversely, if the funding rate is negative, it indicates that the contract market is primarily bearish, and short sellers will need to pay an additional fee to long investors.
Through this mechanism, market balance between longs and shorts can be maintained, preventing excessive discrepancies between contract prices and actual prices.
4. Cross Margin
Cross margin is a margin model in virtual currency contract trading, where all funds in the trader's account are used as margin for the trading position.
Using an isolated margin model allows traders to have more margin to withstand price fluctuations. However, if losses exceed the margin's upper limit, the funds in the account will be wiped out.
5. Isolated Margin
In contrast to isolated margin, the isolated margin allows traders to set the margin independently based on the positions they hold. By using isolated margin, the profits and losses of each position do not interfere with each other, reducing the cross-risk between positions; even if a single position is liquidated, others can still operate independently.
6. Closing the Position
Closing the position means that the investor directly ends the transaction, regardless of profit or loss, during the virtual currency contract trading process.
Common situations that may lead to closing a position include the following:
Manual closing: the trader forcibly ends the trade.
Automatic closing: When the price reaches the pre-specified level set by the trader, the system automatically ends the trade.
Forced closing: When losses exceed the margin's capacity, the system will forcibly close the trade (commonly known as a liquidation).
7. Long and Short Positions
In virtual currency contract trading, investors can choose the direction of their trades based on their preferences. Going long indicates a prediction of rising currency prices, while going short indicates a prediction of declining prices.
Because of this, whether the cryptocurrency market is in a bull or bear phase, traders can find suitable trading opportunities through contract trading.
If you are optimistic about future prices and expect them to rise, you should go long; if you are pessimistic and expect them to fall, you should go short.
8. Stop-loss
Stop-loss is a risk management strategy used in all financial product trading to reduce the risk of loss.
A stop-loss is set by the trader at a specific price point, and when the asset price touches this point, the system will trigger an automatic closing to minimize the trader's losses.
It is worth mentioning that 'stop-loss' is the first lesson every trader must learn when entering the market, because in the rapidly changing financial market, the only thing we can control is our losses!
Only by controlling losses can one survive in the market.
9. Take Profit
Take profit is the opposite of stop-loss; it is a profit protection strategy where traders set a target price. When the market price reaches or exceeds this level, it automatically triggers a closing to secure profits.
10. Margin
Margin is the capital required in virtual currency contract trading to ensure that the trading position can fulfill the contract. The greater the leverage, the less margin is needed for the same position.
In virtual currency contract trading, investors do not actually trade cryptocurrencies. The margin serves as a deposit when trading contracts; every contract transaction requires margin as collateral (considered the invested principal). If the loss amount exceeds the margin, a forced closing will occur.
11. Whale
A whale refers to large investors or institutions that hold substantial amounts of capital in the virtual currency market.
Whales holding large amounts of cryptocurrency assets can influence the entire virtual currency market with their trading actions.
Because of this, certain specific traders or investors will often pay attention to the movements of whales before executing any trading actions to formulate corresponding trading strategies.
12. Retail Investors
Retail investors or new investors with relatively smaller amounts of capital are referred to as 'retail investors'.
Due to the nature of these types of investors, who often lack market information and expertise, they are easily influenced by market fluctuations and make impulsive trading decisions, often leading to losses, which is commonly referred to as 'getting cut' or 'getting harvested'.