How to avoid being “bloodbathed” by the contract market?

Text | Litchi

Editor | Bi Tongtong

Produced by | PANews

March is drawing to a close, and there are only two months left before the Bitcoin halving. However, Bitcoin has not only failed to achieve the expected halving trend, but has continued to fall, especially since March 12, when Bitcoin fell from $7,900 to a low of $3,800. The rapid market changes caught investors off guard, and the secondary market was filled with wailing. In fact, under the influence of multiple factors, the Bitcoin crash was inevitable. Compared with the spot market, the most it suffered was a floating loss of the principal, but the contract market was a "bleeding" liquidation, with huge losses.

In the past two years, the cryptocurrency market has fluctuated up and down, and users are used to using contract leverage to magnify their returns, which has caused the futures contract market to explode, with trading volume far exceeding the spot market, and major exchanges have deployed their positions. However, losses will also be magnified with leverage. If you use a 10x long tool, a 10% drop in price will result in the loss of all principal, and there are even 100x and 125x leverage options. In the rapidly downward market, long margins are liquidated, and the market has no surplus funds to take over, entering a price spiral.

Amidst the optimism about the halving and the safe-haven properties of Bitcoin, the longs who continued to increase their positions caused a series of liquidations. PANews mentioned in "Contract "Massacre" Week: 40 million US dollars were liquidated for every 1% fluctuation, and large orders shrank by 81%" that "the total amount of liquidations in the entire network reached 7.965 billion US dollars in the week from March 10 to March 16, affecting a total of 320,500 people. During the peak period on the 12th and 13th, 103,900 and 147,100 people were liquidated every day respectively." The market is cruel, and only those who are smart enough can survive.

Scientifically Control Risks: Funds, Mentality and Tools How to control risks and avoid liquidation is the basic knowledge that everyone needs to know before entering the contract market. However, knowing is easier said than done. Controlling risks is just four words, but it exhausts the entire trading career of many traders. To say that scientifically controlling risks is actually inseparable from three dimensions: funds, mentality and tools.

Let's start with the dimension of funds. Contract trading has not been a low-risk category since its birth, and it requires a lot of funds. Historically, the earliest futures contract trading began with grain trading. In Japan during the shogunate period, landlords everywhere needed a stable source of income, but the price fluctuations of grain agricultural products such as rice were very large, which brought great uncertainty to the income of landlords everywhere. In order to ensure the stability of grain prices, the rice ticket system was born in Japan at that time. In fact, the rice ticket is a contract, which is a hedge for "rice" to ensure the stable cash flow of rice sellers and buyers. In order to ensure that this contract can be executed unconditionally, both parties will provide some margin. If one party attempts to refuse to fulfill its responsibilities, or cannot fulfill its responsibilities due to fluctuations in grain prices, the margin will be compensated to the other party. For these feudal landlords in Japan, they don't worry about the problem of liquidation, and the margin position is only a small part of their wealth. They don't rely on this method to make money, but hope to gain stability through the margin system.

The prototype of futures exchanges in the shogunate era - Dojima Rice Exchange, and then in the 19th century, the establishment of the Chicago Board of Trade marked the rise of modern futures trading. Whether it is digital currency or grain contract trading, it should belong to big money players. Therefore, if a trader does not have a large amount of money to maintain a long-term and stable margin position, then perhaps he is not the one who should do futures trading.

The second is mentality. Mentality is a compulsory course for a trader from entry to mastery. The market of digital currency trading is changing rapidly. It is only suitable for people who can think calmly all the time, not for those who are worried about gains and losses or lack of time. Under what circumstances should we stop losses in time, and under what conditions should we decisively resist orders? Only people with a good mentality can make the right decisions. It is often said in the market that stop-profit and stop-loss are a science, and in the process of stop-profit and stop-loss, keeping calm and thinking independently is always the "holy grail" of trading mentality, which requires long-term practice. In the view of Jesse Livermore, the world's most famous investor, controlling emotions and psychology is one of the three most indispensable characteristics in trading.

Jesse Livermore: Controlling emotions and psychology is the third indispensable tool in trading.

As the saying goes, if you want to do your work well, you must first sharpen your tools. Good tools mean lower risks. The derivatives market is a vast field, with a variety of products and tools that overwhelm traders: leverage, delivery contracts, perpetual contracts, options, leveraged tokens, etc. We call these products "tools". In fact, there is no difference between good and bad tools. The risk-return ratio of different tools does not form a big gap. The real difference lies in whether the user can use them smoothly. For a trader who is used to arbitrage, a combination of various tools may be the best choice; for a trader who is keen on betting on the direction, high leverage will become his preference.

For most ordinary investors, especially those who lack the ability to actively control risks (whether due to lack of funds, poor mentality, or simply not having enough time to watch the market), tools that can passively control risks are the most important, such as leveraged tokens. In addition to investment tools, platform tools are also an important choice. During the currency disaster on March 12, many leading exchanges experienced freezes and downtime, and investors were unable to close their positions, resulting in heavy losses. Therefore, the platform tools of technical stablecoins are also a protective umbrella for investors. The technology of old exchanges such as Gate.io has withstood the test of drastic market conditions. During the period of volatility, there was no freeze in all kinds of transactions on the website, and there were no abnormalities and restrictions on recharge, withdrawal, transfer and other operations.

Established exchanges tend to have more advantages and credibility in market changes, and are more attractive to investors. For example, in the rising market in February, the trading volume and revenue of exchanges generally increased. According to statistics from the overseas data agency CryptoDiffer, in February, the trading revenue of Gate.io increased by 72.2%, Binance increased by 53.8%, OKEx increased by 49.3%, Coinbase increased by 45.5%, and Huobi increased by 26.1%.

Evolution of cryptocurrency investment tools: The birth of leveraged tokens There is such an interesting story. A reporter interviewed a centenarian and asked her the secret of longevity. The old lady said it was very simple, just don't stop breathing. So for cryptocurrency trading, the secret of long-term investment is also very simple, don't blow up your position. For contract investors, this is "easier to know than to do".

Leveraged tokens, which are products between spot and futures and borrowed from traditional financial derivatives markets, have become popular in the recent ups and downs of the market because they will never be liquidated. What are leveraged tokens? This is the most interesting point about leveraged tokens: First of all, leveraged tokens are ERC-20 tokens, which were born in the cryptocurrency circle. In theory, you can even withdraw them to the ETH wallets of ImToken and MetaMask. At the same time, it helps you add leverage. Let's take "BTC3L" on Gate.io as an example. It is a 3x long token for Bitcoin. For example, in a certain market, if BTC rises by 1%, BTC3L will rise by 3%. If BTC falls by 1%, BTC3L will also fall by 3%. Correspondingly, ETH3S is a 3x short token for Ethereum. For example, in a certain market, if ETH falls by 1%, ETH3S will rise by 3%. L stands for Long, which means long, S stands for Short, which means short, and 3 represents the leverage multiple.

However, leveraged tokens are different from traditional leveraged trading. Users do not need to pay any margin when trading leveraged tokens. They can achieve the purpose of trading leverage by simply buying and selling coins. Of course, no margin means that users will not be liquidated. Most people who hear that leveraged tokens will not be liquidated will first admire the wonders of this product, but then they will be puzzled. Why won't leveraged tokens be liquidated? The principle behind it is actually quite complicated. We can try to understand it with simple analogies. First of all, we know that all types of derivatives in the world can actually be generated by combining the four most basic derivatives.

Leveraged tokens are no exception. They are realized by the issuer of the tokens through continuous position adjustment. The issuer's position may be mainly perpetual contracts, and may also have spot, various options, etc., and finally form a net value determined by a financial formula. After rigorous mathematical calculations, this net value just achieves the effect of 3 times long or 3 times short. Because the issuers of the tokens are professional institutions such as Gate.io and FTX, they can flexibly combine various derivatives together and adjust positions according to predetermined rules. This is like an ETF or a basket of products. Therefore, some traders also call leveraged tokens leveraged ETFs.

Automatic rebalancing: You can win without a blow-up. Behind every leveraged token, there are rigorous financial and mathematical arguments. It can ensure that the 3x leveraged token is always 3 times the spot volatility, and users do not need to understand the principles behind it, or even borrow leverage, and can buy leveraged tokens like buying spot. Whether it is Gate.io, Binance or FTX, trading leveraged tokens is on the spot page, without any additional operations. For example, on the latest version of Gate.io, investors can clearly see the 8 sets of leveraged token trading pairs currently provided by selecting ETF in the spot. I would like to mention here that the product layout of the recently revised Gate.io is clearer and the visual experience has been optimized.

(Image source: https://www.gate.io/marketlist)

The most intuitive advantage of leveraged tokens is that they do not require leverage, so there will be no liquidation. This is undoubtedly a magic weapon for users who lack the ability to actively control risks. At the same time, many people who are new to leveraged tokens will have another question: since leveraged tokens have 3x leverage, if the spot price drops by 50%, theoretically 3x longs should drop by 150%. How will leveraged tokens perform in this situation?

Net value changes based on intraday fluctuations (data source: 3X leveraged tokens on Gate.io) If we take the 3X leveraged tokens on Gate.io, which currently have good liquidity, as an example, if the spot volatility is below 10%, the leveraged tokens will strictly maintain a 3-fold change. If the spot volatility exceeds 10%, the increase will be based on the multiple, but at the same time, the rebalancing mechanism will be activated, and the loss will be reduced. For example, if BTC spot rises by 50%, BTC3L will rise strictly by 3 times, that is, 150%, but BTC3S will fall by 81%, not 150%, thanks to the rebalancing strategy of the token issuer.

Of course, the risks and benefits of any derivative are proportional. Users have obtained the right not to blow up their positions through leveraged tokens, but they also have to pay a certain price. The first is the management fee, because the token issuer needs to adjust the position frequently, and may charge a 0.3% daily management fee to hedge risks and market losses; the second is the wear and tear cost, because leveraged tokens are more suitable for one-sided market conditions, and in the repeated shocks of the market, the net value of leveraged tokens will have some wear and tear. The best is the right one. For investors who want to magnify their returns but cannot actively and effectively operate derivatives such as futures options, leveraged tokens are undoubtedly a low-threshold and relatively low-risk investment tool.