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In this guide, we will show you how investors may utilise Bitcoin futures to increase their potential profits by anticipating the future price of BTC.
In our previous chapter on crypto investment, we looked at how staking and lending can help you grow your holdings passively. However, in this chapter, we’ll take a step forwards and look at how you might enhance your holdings by actively investing.
We’ll go into Bitcoin futures in greater detail below, including how they work, why traders use them, the dangers involved, and where to get started.
What are Bitcoin Futures?
First, it’s important to understand what we mean by futures trading. As a first distinction, spot trading is what most people who invest in crypto do right now. They buy or sell a cryptocurrency at the price it is at that moment. This is a spot trade.
A futures trade, or a futures contract, is an agreement between a buyer and a seller – there has to be both in order for a contract to be agreed upon – to speculate on what the price of an asset might be worth in future.
Futures contracts have opened the doors to more traditional investors who may not be ready to allocate funds to the asset itself, but who still want to benefit from its attractive price action.
So for example, if you’d taken out a futures contract in March of 2020 saying that you’d buy Bitcoin in November for $5,000, and someone agreed to sell Bitcoin at $5,000 you’d be laughing as the seller has to sell their Bitcoin at that price.
If, on the other hand, you predicted that Bitcoin would be worth $50,000 in January and someone beat you to it, you’d have to buy that Bitcoin at the inflated price.
There are more intricacies to futures trading than that, and if you want to learn more about it, see our learn guide here.
However, it is crucial to note at this point that Bitcoin futures have become an incredibly popular trading product, as we will explore further below.
Why do traders use futures contracts to trade?
The first key reason futures contracts are used by traders is because they allow an investor to amplify their profits through something called leverage.
Leverage enables an investor to put down a small quantity of money and have access to a larger sum. In markets with 100x leverage, for example, if you put in $1000, you may effectively enter the market with $100,000. Consider another example.
If you enter the market with $1,000 USD and exit after the price has climbed by 2%, you will have made a $20 profit. However, if you trade with a 100x leverage, that 2% would have yielded $2,000 USD, more than tripling your initial investment. Trading on futures markets has the potential to multiply profits more than practically any other type of short-term trading.
However, this comes with the risk of losing money quickly. In futures trading, liquidation occurs when you mistakenly predict market movement and the exchange with which you purchased the contract cancels the order, resulting in the loss of your entire initial investment. There are further advantages.
Setting up a Bitcoin wallet, utilising an exchange they are unfamiliar with, and then buying and storing Bitcoin is an alien experience for many institutional investors.
The collective open interest in Bitcoin futures increased by 175 percent in 2020.
Plus, many home offices and investors use accounting software that might not be able to process the data flows from wallets or exchanges from spot exchanges. Futures trading on the other hand, is something most investors are familiar with.
“Futures contracts have opened the doors to more traditional investors who may not be ready to allocate funds to the asset itself, but who still want to benefit from its attractive price action,” says a spokesperson from AAX, the world’s first digital asset exchange powered by the London Stock Exchange.
What does a trader need to understand about futures trading in crypto?
The first aspect of purchasing futures contracts is that you are not purchasing the underlying asset, in this example, Bitcoin. Instead, you enter into a contract that predicts whether the price will rise (go long) or fall (go short) (to short an asset).
The next step is to understand your leverage alternatives. Different exchanges will provide varying degrees of leverage. You can get 100x leverage at AAX. That means that if you put $1,000 in at 100x leverage, you’d be effectively buying 100,000 contracts worth $100,000.
If you go long and decide to close your position after the price has risen by 5%, you will have made a $5,000 profit. Your profit would be $10,000 if you exited at 10%.
Now, if you make a bad estimate and the market moves in the opposite direction, you will lose the money you invested (and no more). In the preceding example, $1,000.
Leverage functions as a confidence indicator. The more convinced you are of an upward or downhill movement, the more leverage you would use. However, the more leverage you use, the less volatility the contract will allow, which means that even minor price fluctuations will result in your contract being liquidated.
However, putting less leverage into a contract leaves greater room for market fluctuations.
Finally, you must grasp how an exchange interacts with futures contracts. At AAX, for example, the exchange will close the contract before you reach the total amount you put in, ensuring traders do not have to cover larger losses than they anticipated.
For example, if you bet $1,000, AAX would close your position as close to that amount as feasible to avoid future losses. If your losses exceeded $1,000, AAX would make up the difference through something called the Default Fund.
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