Ever since Bitcoin was launched back in 2009, the need for greater liquidity, more transparency and fewer risks has become a non-negotiable aspect of cryptocurrency trading. The volatility of digital assets in general, and Bitcoin in particular, makes any investment a relatively hazardous endeavor. Most traders try to circumvent this by adapting their behavior to the situation. When the price of their asset of choice drops, they buy, when it goes up, they sell. However, this technique isn’t automated and as soon as they close their position, traders are no longer making any profit or protecting the value of their remaining altcoins effectively.
Bitcoin futures contracts, by legally binding a buyer to purchase a set amount of Bitcoin for a predetermined price when the contract expires, offer guarantees as to the evolution of the situation. As for the sellers, they fulfill their role by agreeing to sell their Bitcoins based on those terms. When utilized correctly, this tool allows traders to maximize their returns all while minimizing risks.
What are Futures?
Futures – often short for futures contracts – have been around since the 17th century. The concept itself is therefore anything but new. At the heart of the model is risk mitigation. In the commodities industry, miners, gas or oil producers, farmers, etc. needed a means of securing a more certain price for their future production. By having the assurance that the fruit of their labor would be purchased at an agreed upon date and at a set price, they could plan ahead and not be forced to work towards uncertain ends.
For example, if a farmer was hoping to sell his next harvest of wheat to a baker, by the time he was ready to deliver, the price of wheat could have risen or fallen. In the first case, the baker could have gone bankrupt simply by committing to purchasing grain he couldn’t afford. The second case scenario would have seen the farmer take a considerable financial hit due to the result of his work being devalued. Futures contracts provided the two parties with piece of mind and predictability for their affairs. They also both needed to accept that, even if the price of commodities fluctuated in their favor, they would miss out.
Nowadays, the futures contracts themselves cover a much greater number of products, including cryptocurrencies.
What are Bitcoin Futures?
These financial contracts were introduced by the Cboe (Chicago Board of Options Exchange) in 2017, then followed by the CME (Chicago Mercantile Exchange).
Bitcoin futures are futures contracts which concern set amounts of Bitcoin to be bought or sold at a given date, thus negating any ups or downs the market may have experienced in the meantime.
Because Bitcoin is subject to frequent and important fluctuations, it is a particularly popular trading asset. However, this does also mean that there exists an inherent risk in holding on to any amount of this currency. Thanks to Bitcoin futures, traders have more tools at their disposal to make sounder investments.
There are two futures positions possible: long and short.
Long positions are agreements to purchase a set amount of Bitcoin at a given price when the contract expires. They are ideal for those who think the actual price of Bitcoin will be higher by the time they are willing to buy it. In essence, if they enter a commitment to buy one Bitcoin for $5,000 on March 20, they will pay this price even if the price of BTC on that date is $6,000, thus making a $1,000 profit.
Short positions are an agreement to sell a set amount of Bitcoin for a specific price on the contract’s expiry date. Short positions should be taken by those convinced that the price of Bitcoin will have dropped by that date. If a buyer commits to purchasing one Bitcoin from them for $5,000 on March 20, they will pay this price even if the value of BTC on that date is $4,000. The seller is therefore making a $1,000 profit.
Taking both a “short” and a “long” position on a digital asset one wants to hold for a while mitigates the risk associated with a price drop. The position will provide additional revenue and offset losses for those investors, thus allowing them to feel more comfortable with their “risk-taking” strategies. By adopting this method, traders are able to lock in the price of their assets.
Stabilizing Price Fluctuations
Bitcoin futures provide guarantees as to the future price of this cryptocurrency. They not only allow those directly involved in a contract to know exactly how much they will pay or receive at a given date, but also influence the market as a whole. Hedging, if done on a large scale, has the potential to truly manipulate the evolution of Bitcoin prices.
Speculating is one of the riskier strategies when it comes to Bitcoin futures, as its primary aim is not to protect one’s assets but, instead, to invest heavily on margins. By purchasing contracts shortly before they are due to expire, speculators hope to see a big return on investment if their predictions are correct.
As a gesture of their good faith, the parties who agree on a futures contract must deposit a margin set by the broker or exchange issuing the agreement. Traders need to have a margin account with enough balance available to open the position. This margin, which usually represents between 2 and 10% of the total value of the contract, will then be transferred to and held by a clearing firm.
An additional margin, which depends on the current price of the asset, must be escrowed at all times for the position to remain open. If it loses in value, the traders will need to top up their account or give up on their position.
This method still allows futures to be traded even if the traders don’t possess the amount of money the assets listed on the futures contract are worth.
Bitcoin Futures trading
It is important to note that futures contracts are regulated, standardized and free of counterparty risk, since clearing firms are there to guarantee they will be honored.
Bitcoin Futures investors start by making a margin deposit with their broker, who is in charge of making sure everything is in order with the clearing firm and informs them as to the maintenance margin. Traders therefore gain money if their maintenance margins are sufficient to cover the fluctuations of Bitcoin prices and may even make a profit if they exceed the required amount. On the other hand, if the initial deposit no longer covers these fluctuations, they will need to add money to their fund, which they may never get back.
Where Bitcoin futures become interesting for those who do not necessarily intend on buying Bitcoin is when the contracts themselves are used as a commodity. Indeed, contracts may be traded and change hands right up until the day they expire. Purchasing futures gives the traders control over the amount of Bitcoin stipulated in the contract in question without actually buying BTC. During the time that they are holding this position, the price of Bitcoin will fluctuate and have an impact on the value of the futures contract, thus affecting the maintenance margin. At any moment, the contract may be sold and the traders will either prevent further loss or receive the value put on top of their margin. If the price of Bitcoin went up, thereby increasing the value of the contract, they would pocket in the difference.
Where can I trade Bitcoin Futures?
Those interested in purchasing Bitcoin futures to go long (or bet on the price of Bitcoin going up) or to go short (or bet on the price of Bitcoin going down) may potentially profit from their accurate guess. To that end, they have three main options at their disposal.
Purchasing and selling Bitcoin futures on an exchange offers the advantages which come with all well-rounded platforms, including:
Adequate levels of security and reliability as verified by large numbers of users
Many options to choose from, each with different functionalities / user interface
Sometimes active, helpful online communities
Commissions usually based on transaction volumes
There are also some downsides to trading futures on an exchange, such as:
Complicated user experience for beginners
Customer support not always available
Frequent cyber attacks
Not always officially regulated
Buying futures through a broker is often the preferred solution for beginners, as the advantages will put their minds at ease:
Highly regulated professionals
High quality customer support
Higher leverage ratios
Many deposit and withdrawal options (PayPal, credit or debit card, Neteller, Skrill, bank transfer…)
However, some traders don’t appreciate this option due to a few drawbacks:
Higher trading costs
Possible additional charges
Brokers more exposed to significant losses
Weekend trading sometimes impossible
The Chicago Mercantile Exchange is a completely transparent, highly regulated and perfectly legitimate actor in futures trading. While it normally trades energy, agriculture, foreign exchange, industrial, etc.-related futures, it now offers a very reliable option for those interested in Bitcoin. It provides:
Cash-settled futures in USD
Sunday to Friday daytime trading
Many brokers go through the CME to carry out transactions as the platform is extremely renowned and the commissions applied are reasonable.
Ultimately, the most important aspect of Bitcoin futures trading is to use it as a tool to achieve your specific end. It may be seen as a complimentary method to make the most of Bitcoin trading or stand on its own and generate profit.
Before you select a platform or broker to carry out your transactions, do some research and compare prices as they may vary greatly. Some brokers will even allow you to test your strategies before “going live” so you’ll know exactly what to expect.