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 unlocked new strategies for Bitcoin traders.

Bitcoin is the most popular cryptocurrency.

by market capitalisation It, like other cryptocurrencies, is extremely volatile. In March 2020, for example, Bitcoin’s price nearly half in a matter of days as markets collapsed amid pandemic panic. By early September, it had risen from around $4,000 to highs of $12,000 before plummeting back to around $10,000.

Spot trading, or the practise of buying and selling Bitcoin on the spot, requires traders to swap cryptocurrencies at their current rates. 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 purchase or sell an item at a particular time, amount, and price. For example, in mid-March, you may arrange to acquire one Bitcoin for $4,000 on August 30. You might also be on the opposite end of the transaction, agreeing to sell a Bitcoin for a certain price. If you are a buyer, you want the trading price of Bitcoin to rise so that you may purchase the cryptocurrency at a lower price, but sellers desire the reverse, benefiting if the price of Bitcoin falls.

People have gone nuts for Bitcoin futures contracts, as big players like CME Group and TD Ameritrade have entered the space. When Bitcoin futures debuted on the Chicago Board Options Exchange (CBOE) in December 2017, the CBOE website was overwhelmed. On Bakkt, the Bitcoin futures platform operated by the Intercontinental Exchange, about 11,000 futures contracts are traded each day.

In the past 24 hours (as of September 10), $2.03 billion worth of futures contracts were traded on Binance; $2.01 on Huobi; $1.85 on OKEx; and $1.05 on BitMEX.

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. However, they wanted to ensure that the rice they were paid for in, say, February would retain its worth until August, so they exchanged contracts requiring the signee to pay out the equal quantity of rice in August, regardless of its present value.

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The advantage of trading Bitcoin futures over, say, buying lots of Bitcoin worth $4,000 at the moment is that you don’t have to hold them personally. (Our Japanese samurai example comes in handy here—the Japanese samurai bought futures contracts to avoid having to store the rice personally.)

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

Nick Cowan, CEO of the GSX Group, told Decrypt: “BTC futures are a great way to bring in additional liquidity to the market and also provide great crypto arbitrage opportunities.” Instead, they are exchanged in the same way that other assets are. As the market value of Bitcoin fluctuates, so will the value of various Bitcoin futures contracts.

When entering a futures contract, a trader has three options for exiting the position: offsetting, rollovers, and expiration. The most frequent is offsetting, which occurs when a trader writes another futures contract of similar value and size, thereby reducing their liabilities to zero as they balance out. Rolling over is accomplished by offsetting a position but with a later expiry date. Expiry is exactly what it sounds like: it occurs when a contract approaches its expiration date and the parties that hold the contract purchase or sell at the agreed-upon 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.

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 existence, Bitcoin has demonstrated that the only constant is price volatility, and while the renowned cryptocurrency is currently on a bull run, there is no predicting what the future holds for Bitcoin. If you speculate at the wrong moment, you may be stuck with a future asset that isn’t worth it.

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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 credible market forecasts, and have enough common sense to reject false claims. Finally, Bitcoin futures are speculative, but excellent information may be used on a best-effort basis. However, doing so is not straightforward, thus one could say that Bitcoin futures are not easily available to the common individual.

The flipside of this is that Bitcoin futures are an excellent method to capitalise on a rising market price. If an investor picks the proper time, there may 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 moment. 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 paid 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 implies that no complicated software or technological skill is required to participate in this area.

Trading on margin

Margin trading is one element of Bitcoin futures, which effectively implies that an investor just needs a portion of a contract’s total to participate.

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

Cryptocurrency shorts

Shorting is an investing technique that includes making an investment with the goal of profiting from a decline in the market value of an asset. Futures and their values are constantly changing, thus there are numerous possibilities for a knowledgeable investor to short a Bitcoin future at any moment.

Assume the Bitcoin market is in the midst of a crypto winter like to 2017. An investor can continue to repurchase their future and perhaps earn a profit.

Platforms for Bitcoin Futures

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.

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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.

A word of caution about Bitcoin futures

Bitcoin futures trading isn’t all fun and games. Taking up a contract is a significant 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 accessible; trading Bitcoin, like all cryptocurrencies, is very hazardous.

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