Let’s say you own 100 BTC and you want to hedge them. You have two options: short sell 100 BTC/USD on an exchange with margin trading, or sell 100 BTC futures. Which is better?

# Arguments for Margin

Margin trading has two great properties.

The first is fungibility. Let’s say you own 100 BTC on Coinbase and hedge it by shorting 100 BTC/USD on margin on Kraken at a price of $8,000. You can then send your 100 BTC over from Coinbase to Kraken, and immediately settle. Because your short position is literally a BTC short, you can combine your 100 BTC long with your {100 BTC short,$800k long} together to generate 800,000 US dollars, and then withdraw those dollars. You could then send those US dollars back to Coinbase and buy back your BTC, successfully completing an arbitrage in a day or less.

On the other hand, let’s say you shorted 100 BTC futures on BitMEX (say the June expiring quarterly futures) to hedge your Coinbase BTC. Sure, you can send your BTC over to BitMEX to use as collateral for your BTC futures short position, but you can’t then settle the position and withdraw any USD. The BitMEX BTC futures don’t really become fungible with real, physical bitcoins until the expiration date at the end of the quarter.

This means that while you can close down a margin hedge in a day, it often takes months to close down a futures position, and your 100 BTC of capital is tied up the entire time.

The second large advantage of margin trading is no premium. Because you can complete an arbitrage cycle between spot BTC and margin BTC in a day, any large pricing discrepancy between a spot and margin BTC/USD exchange could be closed and would only tie up capital for 24 hours. So even though Kraken has BTC/USD margin trading, it generally trades at almost exactly the same price as BTC/USD on Coinbase. This means that, with margin trading, you are given leverage on a market that trades at exactly the same price as spot; you don’t have to worry about losing money to premia!

Futures, on the other hand, can trade at large premia. Because it can take 3 months to unlock capital from a futures trade, nothing forces futures contracts to trade at the same price as spot, and in fact they don’t. If you sell BTC June futures on Deribit right now, you’re losing about 0.10% versus selling spot BTC.

# Arguments for Futures

This makes it seem like margin is just better than futures. All the same leverage, but added fungibility and pricing certainty!

But there’s a catch. After you short sold the BTC on Kraken but before you sent over your BTC from Coinbase, you’d just sold BTC you didn’t own (at least not on the platform). If the person you sold the 100 BTC to tried to withdraw, they’re stuck — there’s no BTC there to withdraw! Similarly, if the ‘USD’ you got from shorting BTC came from someone going long, maybe the USD doesn’t actually exist on the platform either, and so you can’t withdraw it. All of a sudden this whole fungibility argument starts breaking down if you aren’t actually able to withdraw your proceeds.

The key thing here is that margin trading relies on borrows. In order to sell my 100 BTC, I had to first borrow those bitcoins from someone else on Kraken; then if the person I sold to tried to withdraw the BTC, they could withdraw the lender’s 100 BTC instead. But now the lender’s 100 BTC is locked up for as long as it takes me to settle my trade.

There’s no free lunch here. If you want a leveraged trade to be fungible on your end it has to be fungible on the other end as well; if you want them to settle you also have to be able to settle. But the only reason you use leverage is because you can’t settle! So in order to have it both ways you need to recruit a third person to the trade who spots you the physical assets (BTC in this case) to facilitate settlement, and now they’re stuck without access to their capital until you actually deposit your 100 BTC.

1. Trade futures, and you can’t get delivery for months.

2. Trade spot margin; you can get delivery, but in return you have to pay someone to settle your side for you.

And so if you want to short sell 10,000 BTC at once on spot margin you both have to find someone willing to lend you 10,000 BTC, and pay them for it; and that might not be cheap.

Futures, on the other hand, don’t require borrows because no one is expected to deliver until expiration. And so just as you don’t get what you bought, you don’t have to deliver — or borrow — what you sold.

# Which should you use?

In the end it really depends on your particular situation, and the exchanges involved. Here are the questions we run through to evaluate an exchange when we’re using leverage:

1. How much size do we need to trade, and can we actually get a borrow for that size on the platform?
2. How much interest are we going to be paying on the borrow?
3. Do we actually need delivery of the other side?
4. How long will we need to keep the position open for?

1. How liquid are the futures contracts, and how much might we move the premium?
3. Are we worried about massive liquidity failures and liquidations on the platform?
4. When do the futures expire?

# How does FTX fit into this?

FTX offers two types of products: quarterly futures and perpetual futures.

Quarterly futures are your friend if you don’t need fungibility or want to hold a position for a long time. The order books are extremely liquid, you won’t have to deliver anything, and there are no other payments.

The perpetual futures are great for trades you expect to unwind soon. Because of the funding payments, their pricing tracks spot BTC prices closely, making trading them close to trading spot on margin.

Finally, leveraged tokens allow you to target an exposure to the market without having to micromanage your margin or collateral.

Sam Bankman-Fried