Occasionally, headlines emerge about liquidations of $100 million or more in Bitcoin and cryptocurrency futures contracts, leading novice investors and non-expert analysts to point to excessive leverage as the culprit. Gamblers are undoubtedly largely responsible for these high-risk bets, especially when liquidations are concentrated on retail-oriented exchanges such as Bybit and Binance, but not every futures liquidation is the result of reckless use of leverage.
However, not all futures liquidations are caused by leverage.
Some trading strategies used by professionals can also be liquidated during sudden, dramatic price movements, but this does not necessarily represent a loss or a sign of excessive leverage. CME, OKX, and Deribit typically display much lower liquidation ratios than retail-oriented exchanges, indicating that these traders often employ more advanced strategies. Using the futures market, especially perpetual contracts (inverse swaps), is relatively simple. Almost every cryptocurrency exchange offers 20x or higher leverage and requires only an initial deposit, the so-called margin. However, unlike regular spot trading, futures contracts cannot be withdrawn from the exchange. These leveraged futures contracts are synthetic, but they also offer the possibility of shorting, i.e., betting on a price drop. These derivatives offer unique advantages and can improve a trader's results, but overconfident traders rarely make a profit in the medium to long term. To avoid falling into this psychological trap, professional traders often employ four different strategies to maximize profits, rather than relying solely on directional trading.
Forced liquidation on low liquidity pairs
Whales use futures contracts to take advantage of volatile markets by targeting low-liquidity pairs. They open highly leveraged positions in anticipation of forced liquidation due to insufficient margin. This triggers a chain reaction that moves markets in their preferred direction. For example, if you want the price to fall, you will sell in large quantities, causing other traders to be liquidated and sell with them, pushing the price further down. Although it may seem like you are losing money initially, the cascading effect favors the strategy. Executing this strategy requires significant capital and multiple accounts. This effectively uses market mechanisms to create significant impact, and understanding market behavior is critical to this approach.
Cash and Carry Transactions
Cash and carry trading involves buying an asset in the spot market and simultaneously selling a futures contract on that asset. This strategy locks in the spread between the spot and futures prices. The trader holds the asset until the futures contract expires, profiting from the convergence of those prices at expiration. This arbitrage method is low risk and exploits pricing inefficiencies between markets. It works particularly well in stable markets and provides consistent returns regardless of overall market volatility, making it a preferred strategy for risk-averse investors.
Funding Rate Arbitrage
Perpetual contracts (inverse swaps) are typically charged a funding rate every eight hours to balance buyers and sellers. This rate changes with the market demand for leverage. When buyers (longs) demand more leverage, the funding rate becomes positive, making the buyer pay the fee. Market makers and arbitrage desks take advantage of these differences by opening leveraged positions and hedging them by buying and selling in the spot market. They also explore differences between different exchanges or between perpetual and monthly contracts. This strategy, called funding rate arbitrage, involves taking advantage of different rates across the market and requires constant monitoring and precise execution to maximize profits while effectively managing risk.
Using Advanced Strategies on TradingView
The last method I recommend, which is also used by my internal partners, is to use the strategies released by professional investors on TradingView. For example, I have released the following three strategies on TV, which are suitable for short-term players to do swing trading without fear of extreme market conditions (no sharp drop or rise will miss out), and are very suitable for long-term and spot players.
In summary, using derivatives requires knowledge, experience, and a large capital reserve to cope with market volatility. However, strategies like funding rate arbitrage are effective even in less volatile markets, where price action is small. These methods prove that leverage can be used prudently to maximize profits even in calmer market conditions.