Whenever there is data on Bitcoin futures liquidation, many new investors will instinctively conclude that these are regressive gamblers using high leverage or other risky instruments. There is no doubt that some derivatives exchanges encourage retail traders to use excessive leverage, but that is not the whole story of the derivatives market.
Nithin Kamath, CEO of Zerodha, recently questioned how derivative exchanges can handle extreme volatility while offering 100x leverage.
On June 16, 2021, Huobi temporarily reduced the maximum trading leverage to 5x for new users. At the end of the month, the exchange banned users in China from trading derivatives on its platform.
After some regulatory pressure and complaints from the community, Binance futures contracts limited new users leveraged trading to 20x on July 19. A week later, FTX followed suit. the same line under the pretext of “encouraging responsible trading”.
FTX founder Sam Bankman-Fried asserts that the average leverage position is around 2x and that only “a small fraction of the activity on the platform” is affected. It is not clear whether these decisions are coordinated by several regulatory bodies.
3 Ways To Use Bitcoin Futures To Make A Profit
Margin traders keep most of their coins in cold wallets
Most investors understand the benefits of maintaining the highest possible percentage of coins on cold wallets as limiting the internet frequency of coins can greatly reduce the risk of being hacked. However, the downside of this move is that they cannot send their coins to the exchange at the right time, especially when the network is congested.
For this reason, futures contracts are a preferred tool for professional traders to use when they want to reduce their positions during volatile market times. For example, by depositing a small amount of 5% of their holdings, traders can leverage it 10 times and significantly reduce their net exposure.
These traders can then sell their positions on the spot exchanges after their trade arrives and simultaneously close the short position. The opposite should be done for traders who want to increase their exposure suddenly using futures. The derivative position will be closed when the funds (or stablecoins) are transferred to the exchange.
Liquidation by floor
Sharks know that during volatile market times, liquidity often drops. As a result, some will intentionally open highly leveraged positions, expecting them to be liquidated.
Although they lose money with this trade, their aim is to get a series of stops to be triggered. This will lead to cascade liquidations and direct the market move to their wishes. Of course, a trader needs a large amount of capital and can have multiple accounts to make such a move.
Leveraged traders profit from funding rate
Perpetual futures contracts have a funding rate that is calculated every eight hours. Funding rate ensures that there is no risk imbalance on the exchange. Although both buyer and seller open positions are filled at all times, the actual leverage used may vary.
When buyers (longs) are more leveraged, the funding rate will be positive. Therefore, these buyers will be the payers.
The professional trader will continuously monitor these rates and eventually open a leveraged position to collect those fees. While it sounds easy to do, these traders will have to protect their positions by buying (or selling) in the spot market.
Using derivatives requires knowledge, experience, and preferably a large cash reserve to withstand periods of volatility. However, as discussed above, you can completely use leverage without being a reckless trader.