Inverse Futures Contract
What is an inverse futures contract?
An inverse futures contract, commonly known as COIN-margined contract, is a derivative quoted in USD but margined and settled in cryptocurrency. Traders provide cryptocurrency as collateral and incur profit and loss in the same cryptocurrency. For example, an inverse futures contract on ETH is quoted in USD but settled in ETH. This structure allows traders to speculate on price movements without holding significant fiat or stablecoins.
How does an inverse futures contract work?
The profit and loss (P&L) for an inverse futures contract are calculated using the formula:
In inverse contracts, such as ETH/USD, long position holders benefit from ETH’s appreciation against USD. As ETH's price rises, the value of the investor's holdings increases proportionally.
For example, if a trader goes long 1 ETH of ETH/USD inverse contract at $3,000, the price later increases to $4,000.
The trader’s profit will be:
The difference between linear futures contracts and inverse futures contracts
| Attributes | Linear Contract (ETH/USD) | Inverse Contract (ETH/USD) |
|---|---|---|
Settlement Currency | USDT (stablecoin) | ETH (cryptocurrency) |
Margin | USDT | ETH |
P&L Calculation | P&L denominated in USDT | P&L denominated in ETH |
Advantages of inverse futures contracts
Leverage in Bull Markets
The design of inverse contracts creates a higher leverage effect, as the value of the margin fluctuates with the underlying asset's price, potentially offering greater leverage to traders. Also, the direct correlation between the cryptocurrency's price and the USD-denominated inverse contracts provides a straightforward way for investors to capitalize on favorable market movements. It allows traders to profit from crypto’s price appreciation without needing to convert their gains to fiat currency, making it an attractive option for those bullish on cryptocurrency values.
Long-term Crypto Accumulation
By settling profits in cryptocurrency, these instruments provide a direct pathway for reinvestment. This mechanism is particularly beneficial for miners and long-term investors, enabling them to steadily increase their crypto positions without frequent conversions between fiat and cryptocurrencies.
Risks associated with inverse futures contracts
One risk associated with inverse futures contracts is the inability to engage in cross-currency trading. This limitation can restrict trading strategies for those looking to diversify across different cryptocurrencies. Moreover, the inherent volatility of the settlement currency, such as ETH, poses a challenge, as traders are exposed to market risks related to the collateral itself. During periods of high market volatility, the convexity effect can amplify losses, which is why platforms like LongOnly cap leverage at 10x. We advocate for low leverage and long-term positions to minimize risks while benefiting from the inherent volatility in the crypto markets.
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