Most traders think that futures contracts are only used to place high-risk, high-leverage bets, but the instruments actually have a variety of uses.
Whenever there is data on the settlement of futures contracts, many novice investors and analysts instinctively conclude that they are degenerate users using high leverage or other risky instruments. There is no doubt that some derivatives exchanges are known to incentivize retail to use excessive leverage, but that does not account for the entire derivatives market.
Margin traders keep most of their cryptocurrencies in rigid wallets
Most investors understand the benefit of keeping as many coins as possible in a cold wallet because preventing access to tokens on the internet greatly decreases the risk of hacking. The downside, of course, is that this position might not make it to the exchange on time, especially when networks are congested.
For this reason, futures contracts are the preferred instruments traders use when they want to reduce their position during volatile markets. For example, by depositing a small margin such as 5% of their holdings, an investor can take advantage of it 10 times and greatly reduce their net exposure.
These traders could sell their positions on spot exchanges later after their trade arrives and simultaneously close the short position. The opposite should be done for those looking to suddenly increase their exposure using futures contracts. The derivatives position will be closed when the money (or stablecoins) hits the spot market.
Force Cascading Liquidations
Whales know that during volatile markets, liquidity tends to shrink. As a result, some will intentionally open highly leveraged positions, expecting them to be forcibly canceled due to insufficient margins.
While they are “apparently” losing money in trading, they were actually intended to force cascading sell-offs to push the market in its preferred direction. Of course, a trader needs a large amount of capital and potentially multiple accounts to execute such a feat.
Leverage traders benefit from the ‘funding rate’
Perpetual contracts, also known as reverse swaps, have an implicit rate that is generally charged every eight hours. The financing rates ensure that there are no currency risk imbalances. Although the open interest of buyers and sellers coincide at all times, the actual leverage used may vary.
When the (long) buyers demand the most leverage, the finance rate becomes positive. So those buyers will be the ones paying the fees.
Market makers and arbitration desks will constantly monitor these fees and eventually open a leverage position to collect such fees. While it sounds easy to execute, these traders will need to hedge their positions by buying (or selling) on the spot market.
Using derivatives requires knowledge, experience, and preferably a considerable war chest to withstand periods of volatility. However, as shown above, it is possible to use leverage without being a reckless trader.