Mastering Perpetual Contracts: Understanding U-Based and Currency-Based Contracts and Avoiding Financial Pitfalls

The Essence of Contract Trading

Contract trading in the cryptocurrency sphere is a derivative instrument that enables investors to engage in virtual currency transactions through long and short positions, as well as leverage. This method amplifies potential gains during price surges and allows for profit generation even in bearish markets. By incorporating leverage, traders can participate in more significant market movements with relatively modest capital.

It's important to note that due to the unique structure of contract trading rules, cryptocurrency prices in contract trading may deviate from spot market prices. This discrepancy is normal and can widen during extreme market fluctuations, underscoring the need for careful risk assessment when engaging in contract trading.

The Mechanics of Contract Trading

At its core, contract trading allows investors to borrow fiat or cryptocurrency to buy or sell virtual currencies at predetermined future prices.

Consider this scenario: An investor named Alex has 100 USDT and anticipates Bitcoin's price to double from 100 to 200 within a day. Alex could potentially borrow 900 USDT from Gate, use the total 1,000 USDT to acquire 10 Bitcoins, and sell them when the price reaches 200. After repaying the 900 USDT loan, Alex's profit would be 1,000 USDT.

Had Alex used only the original 100 USDT capital, the profit would have been limited to 100 USDT. In this example, Alex employed 10x leverage, resulting in a tenfold increase in profits from a long position on Bitcoin.

In practice, Gate doesn't actually lend money directly. Instead, it utilizes similar calculation methods to clearly display leverage multiples and potential profits or losses, making it more accessible for a broader range of investors.

The Risks of Contract Trading

While Alex's scenario demonstrates the potential for amplified profits through successful market prediction, it's crucial to understand that incorrect predictions can lead to substantial losses or even total capital depletion.

For instance, if Bitcoin's price were to plummet instead of rise, Alex's position could quickly turn unfavorable. A drop to 95 would reduce the value of Alex's 10 Bitcoins to 950 USDT. Choosing to cut losses at this point would result in a 50 USDT loss after repaying the 900 USDT loan.

Should Alex refuse to accept the loss and the price continues to fall to 90, the Bitcoin holdings would only be worth 900 USDT. At this point, Gate might force liquidation to recoup its loan, leaving Alex's account empty – a situation commonly referred to as "liquidation" or "getting liquidated".

In essence, while contract trading can magnify profits when market trends align with expectations, it can equally amplify losses or lead to total capital loss when predictions are incorrect.

Weighing the Pros and Cons of Contract Trading

Advantages

1. Profit Amplification: Leverage allows traders to control larger positions with less capital, potentially leading to higher returns when market trends align with predictions.

2. Profit Potential in Bearish Markets: Contract trading enables profit generation through short selling during market downturns.

3. Advanced Strategies: Experienced traders can employ sophisticated techniques like hedging to manage risk effectively.

Disadvantages

1. Liquidation Risk: The high leverage involved in contract trading significantly increases the potential for substantial losses or complete liquidation.

2. Knowledge Requirement: Successful contract trading demands a solid understanding of market dynamics and analytical skills, potentially posing higher risks for inexperienced investors.

Contract Trading Categories

Contract trading can be classified based on delivery time (delivery contracts vs. perpetual contracts) and pricing units (U-based contracts vs. currency-based contracts).

Delivery Contracts

These are contracts with predetermined expiration dates, also known as futures contracts. They require the delivery of a specified amount of assets on a specific future date. The system automatically closes and settles positions at the agreed time, regardless of profit or loss.

Perpetual Contracts

Perpetual contracts have no expiration date, allowing investors to hold positions indefinitely. They incorporate funding rates to maintain price stability, which can be understood as interest paid for borrowing funds to open and close positions.

U-Based Contracts

U-based contracts use stablecoins (typically USDT) as the unit of account. They allow investors to evaluate contract value and risk more intuitively and participate in the cryptocurrency market without directly purchasing the underlying asset.

Currency-Based Contracts

These contracts use cryptocurrencies as the unit of account, allowing investors to participate in the market directly using virtual currencies without converting to stablecoins.

Mitigating Liquidation Risk

1. Leverage Control: Higher leverage increases liquidation risk. For example, 10x leverage may result in liquidation if the price moves 10% against your position, while 100x leverage could lead to liquidation with just a 1% adverse price movement.

2. Stop-Loss Implementation: Setting stop-loss orders is an effective risk management tool that automatically closes positions when losses reach a predetermined level, preventing further losses or total capital depletion.

Key Terminology in Contract Trading

• Futures Contract: Also referred to as "Contract" or "Futures" (not to be confused with "Future").
• Swap: Commonly used in European and American exchanges, often interchangeable with "Futures" in cryptocurrency contract trading.
• Derivative: A broader term encompassing various financial instruments, including contracts, options, ETFs, and indices.

By understanding these concepts and implementing prudent risk management strategies, traders can navigate the complex world of cryptocurrency contract trading more effectively.