With cryptocurrencies like Bitcoin and Ethereum gaining popularity worldwide, more and more newcomers are getting involved with crypto exchange. For risk-averse enthusiasts, spot trading is a great option where they can purchase digital assets and hold them for an extended period. However, futures trading is a major attraction for those who wish to capitalize further on the market movements.
Futures Trading can be one of the most convenient methods to get exposure to cryptocurrency. This article offers a comprehensive guide that will give you a simplified explanation of futures trading.
Futures, a form of derivative trading product, are regulated trading contracts between two parties where they agree to purchase and sell some asset at a specific price on a certain date. Through Futures trading, investors can have protection against volatile markets and make purchases or sell the assets at the pre-determined price in the future.
Cryptocurrency futures are future contracts for investors wishing to bet on crypto's future price. With these, investors get an opportunity to select cryptocurrencies without purchasing them. These work similarly to a standard futures contract, where you can bet on the price trajectory of a given asset.
Before indulging in the Futures contract, you must be aware of the three main components of a crypto futures contract.
The expiration date is the date when the involved parties must settle the contract. It's the last date on which one party has to sell, and the other party has to purchase the underlying crypto at a pre-determined price. However, if the traders wish, they can sell to the other investors before the settlement date.
Units per contract feature the worth of each contract of the underlying asset. This value can differ depending on the platform you choose. For instance, the value of one Bitcoin Futures contract on CME is 5 Bitcoins (denominated in USD). However, the value of one Bitcoin Futures contract on Deribit is $10 worth of Bitcoin.
The exchange platforms allow futures traders to borrow a certain amount of capital to aid them to increase their trading size. This assists in increasing the potential profit of the traders through their future bets. This borrowable amount is referred to as leverage. The leverage rates vary greatly based on the exchange platform you choose. While the users can supercharge their trades by up to 50x with Kraken, FTX has reduced its leverage rates significantly, dropping it from 100x to 20x.
There are two major ways in which traders can settle a futures contract.
In the case of purchasing and selling the Bitcoin futures contracts, the investors are particularly speculating on the future price trends of Bitcoin. When the two parties make a bet or enter into a contract, one of them believes that the price of Bitcoin will rise in the future, and the other one believes that in the future, the price of BTC will fall. The party whose prediction or analysis is wrong has to pay the other party the cash settlement.
Various futures contracts are meant for currencies, stock indexes, and commodities. The regulation of the overall futures market is carried out by CTFC (Commodity Futures Trading Commission). This agency considers Bitcoin a commodity, and hence, Bitcoin futures come under the commodity futures category.
Investors can trade the Bitcoin Futures contracts on the Chicago Mercantile Exchange (CME), where they can find monthly contracts for cash settlements. On CME, users can find the monthly Bitcoin Futures for six months and additional quarterly futures for up to four upcoming quarters. These monthly futures contracts expire on the last Friday of every month. The value of each futures contract on this platform is 5 BTC.
Front-Month Bitcoin Futures
The Front-month futures contracts are the short-term futures contracts of Bitcoin. These are the futures with the nearest expiration dates. These contracts primarily trade closest to the spot price of Bitcoin. Depending on the view and beliefs of the market concerning the upward or downward movement of Bitcoin, these investors can trade above or below the spot price.
Spot price refers to the price of Bitcoin traded on the cryptocurrency exchange platform. Generally, the investors trade the front-month futures contract at a price higher than the current spot price. This condition is referred to as contango. Contango denotes that the masses expect the asset price to be headed in an upward direction in the near future. On the other hand, if the market believes that the asset prices to trade will go down soon, such a condition is called backwardation.
Types of Bitcoin Derivatives
There are mainly four types of Bitcoin derivatives:
In a way, perpetual contracts can be considered a clone of the crypto futures contract. With perpetual contracts, you can add the intuitive ability of the spot traded to the risk-hedging feature of the futures market. The traders can hold a particular position if they have enough funds. Perpetual contracts are a preferred Bitcoin derivative for traders who can invest after every hour to keep the position open.
As the trading exchange platforms integrate options into their derivatives, the traders can purchase or sell any underlying asset within a specific timeline at a strike price that has already been decided. They can choose between the call and the put option. Unlike Futures, in options, traders have no obligation to exercise the option. As the name suggests, it is just an option they have.
When the traders wish to exchange one type of crypto derivate with the other, they can indulge in swaps. This system assists the traders in earning profit at a fixed time later.
Forward is nothing but another clone of the futures. However, the only difference between futures and forwards is that forwards can be customized, which is not the case with futures. Mostly you can trade Forwards via OTC (over the counter). So you must be aware of the associated risks before you indulge in Forwards.
Futures Contracts vs. Perpetual Swap Contracts
The users and investors who have been acquainted with the crypto industry for a considerable period are likely to have come across the term 'perpetual swap contracts. Perpetual contracts, often referred to as Perps operate more or less like futures contracts. Like futures contracts, Perps allow users to purchase or sell the underlying assets at a pre-determined price on a future date.
However, the difference is that there is no expiration date in the Perpetual swap contracts. This means the traders can keep their contracts open for being purchased or sold for as long as they want. There is no expiration date, and they can settle them or sell them to the other trader whenever they feel like it.
Due to the lack of any expiration date on the perpetual swap contracts, there is a special mechanism that ensures that the contract price tracks the current market price as closely as possible. In this system, the buyers and sellers pay a certain periodic fee to the other party, depending on whether the contract price is above or below the market price. The system is referred to as Perpetual Swap Funding Rate.
When the prep futures' price is higher than the market price, the long (buyers) traders will have to pay a fee to the short traders (sellers). This is an attempt to discourage more traders from going long. On the other hand, when the prep futures' price is lower than the market price, the short traders have to pay a fee to the long traders.
Prep funding rates can often be a helpful metric while analyzing the market sentiment around any given asset.
Before indulging in the Futures contract, you must be aware of the three main components of a crypto futures contract.
The expiration date is the date when the involved parties must settle the contract. It's the last date on which one party has to sell, and the other party has to purchase the underlying crypto at a pre-determined price. However, if the traders wish, they can sell to the other investors before the settlement date.
Units per contract feature the worth of each contract of the underlying asset. This value can differ depending on the platform you choose. For instance, the value of one Bitcoin Futures contract on CME is 5 Bitcoins (denominated in USD). However, the value of one Bitcoin Futures contract on Deribit is $10 worth of Bitcoin.
The exchange platforms allow futures traders to borrow a certain amount of capital to aid them to increase their trading size. This assists in increasing the potential profit of the traders through their future bets. This borrowable amount is referred to as leverage. The leverage rates vary greatly based on the exchange platform you choose. While the users can supercharge their trades by up to 50x with Kraken, FTX has reduced its leverage rates significantly, dropping it from 100x to 20x.
There are two major ways in which traders can settle a futures contract.
In the case of purchasing and selling the Bitcoin futures contracts, the investors are particularly speculating on the future price trends of Bitcoin. When the two parties make a bet or enter into a contract, one of them believes that the price of Bitcoin will rise in the future, and the other one believes that in the future, the price of BTC will fall. The party whose prediction or analysis is wrong has to pay the other party the cash settlement.
Various futures contracts are meant for currencies, stock indexes, and commodities. The regulation of the overall futures market is carried out by CTFC (Commodity Futures Trading Commission). This agency considers Bitcoin a commodity, and hence, Bitcoin futures come under the commodity futures category.
Investors can trade the Bitcoin Futures contracts on the Chicago Mercantile Exchange (CME), where they can find monthly contracts for cash settlements. On CME, users can find the monthly Bitcoin Futures for six months and additional quarterly futures for up to four upcoming quarters. These monthly futures contracts expire on the last Friday of every month. The value of each futures contract on this platform is 5 BTC.
Front-Month Bitcoin Futures
The Front-month futures contracts are the short-term futures contracts of Bitcoin. These are the futures with the nearest expiration dates. These contracts primarily trade closest to the spot price of Bitcoin. Depending on the view and beliefs of the market concerning the upward or downward movement of Bitcoin, these investors can trade above or below the spot price.
Spot price refers to the price of Bitcoin traded on the cryptocurrency exchange platform. Generally, the investors trade the front-month futures contract at a price higher than the current spot price. This condition is referred to as contango. Contango denotes that the masses expect the asset price to be headed in an upward direction in the near future. On the other hand, if the market believes that the asset prices to trade will go down soon, such a condition is called backwardation.
Types of Bitcoin Derivatives
There are mainly four types of Bitcoin derivatives:
In a way, perpetual contracts can be considered a clone of the crypto futures contract. With perpetual contracts, you can add the intuitive ability of the spot traded to the risk-hedging feature of the futures market. The traders can hold a particular position if they have enough funds. Perpetual contracts are a preferred Bitcoin derivative for traders who can invest after every hour to keep the position open.
As the trading exchange platforms integrate options into their derivatives, the traders can purchase or sell any underlying asset within a specific timeline at a strike price that has already been decided. They can choose between the call and the put option. Unlike Futures, in options, traders have no obligation to exercise the option. As the name suggests, it is just an option they have.
When the traders wish to exchange one type of crypto derivate with the other, they can indulge in swaps. This system assists the traders in earning profit at a fixed time later.
Forward is nothing but another clone of the futures. However, the only difference between futures and forwards is that forwards can be customized, which is not the case with futures. Mostly you can trade Forwards via OTC (over the counter). So you must be aware of the associated risks before you indulge in Forwards.
Futures Contracts vs. Perpetual Swap Contracts
The users and investors who have been acquainted with the crypto industry for a considerable period are likely to have come across the term 'perpetual swap contracts. Perpetual contracts, often referred to as Perps operate more or less like futures contracts. Like futures contracts, Perps allow users to purchase or sell the underlying assets at a pre-determined price on a future date.
However, the difference is that there is no expiration date in the Perpetual swap contracts. This means the traders can keep their contracts open for being purchased or sold for as long as they want. There is no expiration date, and they can settle them or sell them to the other trader whenever they feel like it.
Due to the lack of any expiration date on the perpetual swap contracts, there is a special mechanism that ensures that the contract price tracks the current market price as closely as possible. In this system, the buyers and sellers pay a certain periodic fee to the other party, depending on whether the contract price is above or below the market price. The system is referred to as Perpetual Swap Funding Rate.
When the prep futures' price is higher than the market price, the long (buyers) traders will have to pay a fee to the short traders (sellers). This is an attempt to discourage more traders from going long. On the other hand, when the prep futures' price is lower than the market price, the short traders have to pay a fee to the long traders.
Prep funding rates can often be a helpful metric while analyzing the market sentiment around any given asset.
Bitcoin Futures work on the same principles as a typical futures contract. Centralized exchanges like Binance offer gigantic risk-taking opportunities to their traders. If we believe that the price will rise, we can purchase, and if we believe that the price will drop, we can go for selling.
For instance, let's say we believe the price will rise and purchase Bitcoin at a futures contract of $40,000, which needs to be settled two months out. Per the contract, we must purchase $40,000 in Bitcoin within two months.
If, at the time, the price is trading at $50,000, then we would make a profit of $10,000 per unit as we purchased at $40,000. However, if the price dropped to $30,000 by that time, we would still have to purchase it at $40,000, meaning we would lose $10,000 per position.
Contrarily, if we believe that the price will drop in the future, we could sell at a $40,000 futures contract under the same conditions. Accordingly, if Bitcoin falls to $30,000 by the expiry date, we would still be selling them at the $40,000 rate and make a profit of $10,000 per position. However, even when the price rises to $50,000 by that time, we would be left with no option but to sell them at the rate of $40,000 and would have to incur a loss of $10,000.
To accept this obligation, we have to put up a minimum required amount, which we refer to as 'margin.' You must have the lowest collateral amount in your account when you wish to execute these futures trades. The amount of money you need to put as a 'margin' in exchange is directly proportional to the money you decide to put into a trade.
Leverage
Higher leverage indicates that you'd be more succumber to greater profits and losses. Plus, the amount that you can trade depends on the margin amount that you have in your account. For instance, in the case of Binance, you get leverage of 125x the trading amount. This leverage rate would determine how volatile your trade would be in terms of gains and losses.
Pros
Bitcoin is regulated by the Commodity Futures Trading Commission (CFTC), which serves as a major plus point for those interested in Bitcoin futures trading. While the CFTC regulation is not as strict as the investment regulators of other commodities like stocks and bonds, it ensures that the speculators and investors abide by certain rules to maintain control and order. This might come as a turn-off for those who decide to invest in crypto to buycott the government's rules. However, it is a positive aspect for Bitcoin enthusiasts in general.
CFTC has introduced a guide that aids in controlling contracts and ensuring that investors and speculators abide by these rules for futures contracts. The rules mentioned are easy to understand and transparent, without ambiguity. Failing to abide by these rules is also presented in advance.
The flexibility of this system is another major benefit of trading Bitcoin futures. Here, you are not trading bitcoins in reality, so you don't need to have a digital wallet to store or trade crypto. Moreover, you don't need to give any physical or underlying asset in exchange for Bitcoin. This feature eliminates the risk of holding Bitcoin, which has a volatile value and increases and decreases in price at any given time.
Most crypto exchange platforms that offer bitcoin futures would give you leverage and position limits to increase your gains. This leverage rate may vary depending on the platform you use. The rate of leverage determines the range of increased profits and losses.
As for the position limit toggle feature, you can manually reconfigure position limits based on your past trades and margin amounts in your account.
Cons
Indulging in Futures trading with Bitcoin is not as simple. You need to have considerable technical skills to make a significant profit in the sector. Before indulging in this ecosystem, you must understand how the crypto market works, study and analyze several market predictions, and have a robust trading framework you can rely on.
Majorly, Bitcoin futures are speculative. However, using some helpful market information from professionals and analysts can sometimes be useful. Filtering information and effectively using the piece of information that is profitable for you need proper knowledge and a certain level of expertise. An average trader generally finds this task difficult.
While the Bitcoin futures contracts offer a more straightforward process of making money in the crypto market, the system is not available for everyone. Centralized exchange platforms like Binance might allow you to start futures trading with a low amount in hand. However, platforms like Cboe and CME are quite expensive.
To add to it, you need to have at least 50% of the trading amount as the marginal security in your account. This, again, is a costly affair and not preferable for regular or small-level traders, as opposed to the 10% margin requirement for futures trading of other assets. As a result, only large-scale, qualified investors participate in Bitcoin Futures trading, especially on platforms like CME and CBOE.
Relationship Between Bitcoin Futures and Bitcoin Price
Simply put, Bitcoin futures contracts should track Bitcoin's price. However, due to the volatile nature of Bitcoin, its price varies throughout its settlement date, resulting in an increase or decrease in bitcoin's spot price due to the Bitcoin Futures contract.
Mostly, this is due to the rapid fluctuations in the crypto's volatility. For instance, if a major country like China decides to ban crypto or a business giant like Tesla starts to make more investments in Bitcoin, the price of Bitcoin can fluctuate dramatically. The resulting issue related to the supply and demand of Bitcoin can result in the widening or shrinking of the spreads in the Bitcoin Futures contracts.
Gaps are another form of a price change that affects the futures trading of Bitcoin. Gaps are periods where no trading is taking place. As a result, there is no pricing data for these time gaps. However, such a situation arises only on traditional trading platforms like CME, which have specific trading hours, unlike the broader market of the crypto universe, that trade 24 hours a day.
You can choose amongst several platforms offering seamless, regulated, or centralized exchange benefits depending on your requirements and preferences. The first exchange for offering Bitcoin Futures contracts was America's Cboe Global Markets (Cboe). It implemented this feature on 10 December 2017. A week later, CME joined the race. Given below is the list of some of the major platforms that offer access to the Bitcoin Futures:
Binance is the biggest cryptocurrency globally, with a total of $4.32 billion in trading volume in Bitcoin Futures.
It was started in 2018 and has a total of $2.30 billion in Bitcoin futures trading volume.
Established in December 2017, just after Cboe, CME is headquartered in the United States. It accounts for $2.24 billion of the total trading volume.
While FTX joined the crypto trading ecosystem quite late, it has shown a quick hike in its popularity across the globe.
OKX is considered one of the biggest cryptocurrency exchange platforms in the world. However, due to specific regulatory compliance reasons, OKX is not available for customers residing in the US.
While there are several ways for enthusiasts to enter into the crypto and Bitcoin ecosystem, there is no perfect way to invest in this sector today. Futures is a great means for anyone interested in cryptocurrency and its trading and looking for fast-paced exposure to the sector without having to worry about digital wallets and security. In addition, with crypto futures, you can implement various strategies and operations like short-selling and scalping, which you couldn't have used in spot markets to succeed at the same rate.
If you properly implement and execute risk-management decisions, crypto trading can be a very profitable option. If you are a regular trader, crypto trading can be more profitable for you than crypto mining because you need to make a huge investment in expensive equipment before you start earning. However, like any other trading form, crypto trading also comes with risks that you should consider while indulging in this industry. Accordingly, you should pick the best strategy per your requirements if you want to explore this space.