What Exactly Are Bitcoin Futures, and How Do They Work?

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Futures contracts have a long and illustrious history, but they have opened new techniques for Bitcoin traders.

Bitcoin has the highest market capitalisation of any cryptocurrency. It, like other cryptocurrencies, is extremely volatile. In March 2020, for example, Bitcoin’s price nearly halved in a matter of days as markets tumbled amid pandemic fear. By early September, it had risen from around $4,000 to highs of $12,000 before plummeting back to under $10,000.

Spot trading, or buying and selling Bitcoin, requires traders to swap cryptocurrencies at their current values. But what if there was a way to lock in that $4,000 price and then pick up the Bitcoin a few months later? So, even if Bitcoin’s price reaches $12,000, the counterparty must deliver the Bitcoin purchase for $4,000.

Yes, there is! It’s known as a futures contract. A futures contract is an agreement between two traders to buy or sell an item at a certain time, amount, and price. For example, in mid-March, you might contract to acquire one Bitcoin for $4,000 on August 30. If you’re a buyer, you want the trading price of Bitcoin to go up, as you will be able to buy the cryptocurrency at below market value, while sellers want the opposite, profiting if Bitcoin were to decrease in price.

BTC Price

People have gone crazy over Bitcoin futures contracts, which have been introduced by major firms such as CME Group and TD Ameritrade. When Bitcoin futures debuted on the Chicago Board Options Exchange (CBOE) in December 2017, the CBOE website was inundated with visitors. Every day, over 11,000 futures contracts are exchanged on Bakkt, the Intercontinental Exchange’s Bitcoin futures market.

Binance has traded $2.03 billion in futures contracts in the last 24 hours (as of September 10), Huobi has traded $2.01 billion, OKEx has exchanged $1.85 billion, and BitMEX has traded $1.05 billion.

 

Futures contracts and the evolution of asset classes

“Futures are an important part of the evolution of asset classes,” Nick Cowan, CEO of the GSX Group, told Decrypt. “They provide a benchmark—a Fair Value, or FV—of what the future value is, allowing arbitrage and liquidity to enter the market.”

Futures contracts originated with 17th-century Japanese samurai, who were paid in rice but were out most of the year doing whatever it is that 17th-century samurai do. But they wanted to ensure that the rice they were paid in, say, February held its value until August, so they traded contracts that obliged the signee to pay out the equivalent amount of rice in August, regardless of its current value.

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The reason why you might trade Bitcoin futures as opposed to just, say, buying lots of Bitcoin worth $4,000 at the time, is that you don’t have to hold them yourself. (Our Japanese samurai analogy is helpful here—the Japanese samurai traded futures contracts so they wouldn’t have to store the rice themselves).

Some crypto exchanges, such as OKEx, have lower trading fees for futures contracts, which means that traders can squeeze a bit more out of their accounts by using futures.

How a trader exits their futures position

“BTC futures are a terrific way to bring in additional liquidity to the market and also present great crypto arbitrage opportunities,” said Nick Cowan, CEO of the GSX Group. This is due to the fact that futures contracts are often not kept until their expiration date. Instead, they are traded in the same way that other assets are. As the trading value of BTC fluctuates, so will the value of various BTC futures contracts.

When entering a futures contract, a trader has three options for exiting the position: offsetting, rollovers, and expiry. The most prevalent is offsetting, which occurs when a trader writes another futures contract of identical value and size, effectively reducing their obligations to zero as they balance out. Rolling over is done by offsetting a position, but with an expiry date that is further into the future. Expiry is what you’d expect: it’s when a contract reaches its end date and the parties who hold the contract buy or sell at the agreed price.

Futures contracts and hedging

Another trading method for futures is hedging. Hedging is a way to reduce risk, which is useful for traders dealing with the volatility of cryptocurrencies.

Consider a trader who just bought three Bitcoin at a $10,000 a pop:

  • 📈 She believes that the price of Bitcoin will rise by the end of the month, but wants to protect her position in case it goes down.
  • 📅 To protect her position, she can enter a futures contract to sell one Bitcoin for $10,000 at the end of the month.
  • 💰 At the end of the month, if Bitcoin has gone up, she will make a profit by selling the remaining two Bitcoin.
  • 📉 If it goes down, she will lose money, but this will be limited as she can still sell one Bitcoin for $10,000.
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Hedging reduces a trader’s overall risk, although it does also limit their potential profits.

The pros and cons of Bitcoin futures

First and foremost: Bitcoin futures are, by definition, speculative investments. In its decade-plus history, Bitcoin has demonstrated that the only constant is price volatility, and while the legendary cryptocurrency is currently on a bull run, there is no predicting what the future holds for Bitcoin. If you speculate at the wrong time, you may be stuck with a future asset that isn’t worth it.

Being an experienced investor has its advantages as well. To use futures successfully, an investor must comprehend market behaviour, have enough expertise to pay attention to realistic market projections, and have enough common sense to reject spurious claims. Ultimately, Bitcoin futures are speculative, but it is possible to leverage good information on a best effort basis. Doing that, however, is not exactly easy, so one might argue that Bitcoin futures are not very accessible for the average person.

The inverse of this is that Bitcoin futures are an excellent strategy to capitalise on a rising market price. If an investor picks the perfect time, there might be a lot of money to be made by leveraging the Bitcoin Futures market.

Bitcoin futures, contrary to popular belief, do not require the ownership of any Bitcoin. Instead, it simply entails exchanging Bitcoin at a future, pre-agreed-upon date, regardless of the price at the time. Understanding the market may not be the easiest chore, but you don’t need any technology to get started, not even a Bitcoin wallet.

 

Cash settlements

Bitcoin futures contracts are settled in cash. Because there is no current Bitcoin trading in a futures market, commitments are met by trading at future, pre-agreed-upon values. Another frequently mentioned feature of the Bitcoin futures market is the ability to settle in cash, which means that no complex software or technological skill is required to participate in this sector.

Trading on margin

Margin trading is one feature of Bitcoin futures, which effectively means that an investor only needs a fraction of a contract’s total to participate.

Leveraging 10-20% of a Bitcoin futures contract means that an investment has a high potential for profit as well as a high chance for loss.

 

Crypto shorts

Shorting is an investment technique that involves making an investment with the purpose of profiting from a reduction in the market value of an asset. Futures and their values are constantly changing, thus there are numerous possibilities for a skilled investor to short a Bitcoin future at any time.

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Assume the Bitcoin market is in the midst of a crypto winter akin to 2017. An investor can continue to repurchase their future and potentially create a profit.

 

Bitcoin futures platforms

Bitcoin futures are traded on several platforms. The top five by open interest at the time of writing are OKEx, Binance, CME, ByBit, and BitMEX.

Bitcoin futures open interest chart
The top Bitcoin futures platforms by open interest in November 2020. Source: Skew
  • OKEx: OXEx’s futures trading volume, the website projects, reaches up to $1.5 billion per day.
  • Binance: The Binance futures market is described on the Binance website as the “fastest-growing crypto-derivative exchange by trading volume,” and offers a leverage of 125x the margin.
  • CME: CME’s Bitcoin futures contract trades on Sunday through to Friday, from 5pm to 4pm Central Time, and expire on the last Friday of each month.
  • ByBit: ByBit offers up to 100x leverage and specializes in perpetual contracts. New users can, according to the ByBit website, receive up to $90 of user benefit.
  • BitMEX: BitMEX offers, according to its website, futures contracts that have “inverse, quanto, and linear payouts,” all of which are explained for users via this table.

Bitcoin futures: a note of caution

Bitcoin futures trading isn’t all fun and games. Taking up a contract is a serious commitment, and if it approaches its expiration date, the trader is legally obligated to fulfil it.

Futures can cost you a lot of money since you may be obliged to buy Bitcoin at a price that is far higher than its current trading price. Cryptocurrencies are one of the most volatile asset classes available; trading Bitcoin, like all cryptocurrencies, is extremely dangerous.

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