What are bitcoin futures and how to deal with them?

What are bitcoin futures and how to deal with them?

Bitcoin (BTC) is an emerging financial instrument traded in the cryptocurrency market. This top digital coin is the epitome of volatility witnessed in the crypto space.

The volatility could be caused by various market factors. An example is the lack of a central bank controlling the coin. Spot trading is also a factor that leads to the price volatility of bitcoin. A spot market is where traders buy and sell assets instantly. This market doesn’t rely on leverage as traders can only sell assets that they own.

Futures is the solution that addresses the inefficiency of spot trading in fixing the price of bitcoin. Bitcoin futures is a form of trading where traders agree to buy and/or sell bitcoin at a future date. Futures present an ideal situation where the market price of a digital currency is stabilized.

How do bitcoin futures work and their difference from commodities futures?

Futures are a type of financial instrument that helps traders to lock in a fixed price for a cryptocurrency in a future date. So, how exactly do bitcoin futures work? Well, you’ll have to understand a few easy things first.

The first thing to note is that there must be at least two traders to trade bitcoin futures. Assuming there are two traders, they come to terms on how they will buy or sell bitcoin at a future date.

Regardless of what the price of bitcoin would be on the crypto market on the date agreed, the trader must sell or buy at the initially agreed price. There are two basic ways to enter into a futures contract i.e. long or short.

Why do you go long, you agree to buy bitcoin at price X on Y date. When you go short, you agree to sell bitcoin at price X on Y date.

Bitcoin futures can be defined easily as a bet of a future price against the current price of bitcoin.

Types of cryptocurrency futures contracts

There are several types that of cryptocurrency futures contracts. Here are the three types that explain the concept of crypto futures well. It is important to note that you might not get all three types on a single trading platform. The broker that you choose will determine the types of futures contracts that you can access.

i.                     Standard futures contract

The aspects of standard futures contracts are borrowed from the traditional financial markets. For example, the concepts of an expiry date and settlement are widely used. This means that a trader must agree with a fellow trader on the expected price of bitcoin the before expiration date. The first time bitcoin futures were introduced in the crypto market was in 2017 by a Chicago-based CME Group. At the time, many people were asking what is bitcoin futures, and couldn’t get to understand the working well.

ii.                   Futures with physical delivery

This is a type of futures that are delivered at the time of settlement. That is the only difference it has with the standard futures contract. Bakkt was the first company to introduce this type of futures.  Currently, the company only delivers bitcoin futures.

iii.                 Perpetual contracts

Perpetual contracts are types of futures that don’t have an expiry date. It relies on funding to keep contracts near the spot price. At certain hours, traders pay each other depending on their open positions. The trader that gets paid is determined by the difference between the contract price and spot price.

History of bitcoin currency futures

Bitcoin futures is a fairly recent trading style. It started in 2017 with a Chicago-based CME Group. They were the first to introduce the standard futures contract. Bakkt, with the backing of Intercontinental Exchange (ICE), also introduced futures with physical delivery. The concept of perpetual contracts was introduced by BitMEX but adapted by major crypto trading brokerage firms.

The only drawback of the initial brokerage firms is that they were unable to focus on the emerging needs of the market. Traders needed leverage in bitcoin futures trading. They could also not handle the trading volume of bitcoin futures. This led to the market acceptance of emerging brokers.

The broker offers lower commission fees and wide leverage for bitcoin futures. It also has great internal features that make BTC trading very seamless. With its EU regulation intact, you will find it a secure and reliable platform to trade bitcoin.

Historical perspective of what futures do to bitcoin

Futures have been used before in trading different commodities. The principality that underlies this concept of training is the control of market volatility. Futures provide a stable market price for commodities since there is a guarantee of their presence in the future.

So, what will futures do to bitcoin? As it is, bitcoin is used as an underlying asset in many trading platforms offering futures. The price fluctuations that have been witnessed are the target of this type of trading. Futures will protect the ‘future price’ of bitcoin to make it more stable.

From a historical perspective, BTC has experienced several unprecedented fluctuations. Just like other digital assets, its future is entirely on increased market acceptability. This can be secured by futures.

Pros and Cons of Bitcoin Futures

If you want to start trading bitcoin futures, you need to understand all the benefits and drawbacks related to it. This will give you a clearer picture of what to expect as you trade.

Benefits of Futures Trading

Here are some of the benefits of futures:

·       Opens the market to risk-tolerant investors

Futures opens the market to traders who would not access the crypto market. These are risk-tolerant investors.

·       Stable margin requirements

There are stable margin requirements when trading BTC futures. It is easy to know the margin that should be put in a contract when trading bitcoin futures.

·       No time decay involved

When trading futures, there is no decline in asset value over time as it is in options trading. The reduction in price value over time reduces the profitability of a trader. In futures, this doesn’t happen because there is a fixed price on a set date.

·       Simple pricing

The mechanism of pricing in futures is very simple. It involves the contract price, which is calculated using the added cost of carrying the spot price. Beginners find it easy to set the price for BTC.

·       Protection against price fluctuations

One of the biggest benefits of trading futures is that it protects you from price fluctuations. Everyone knows how unstable the price of bitcoin can be where a single news event can change its price immediately.

Take the example of Elon Musk’s announcement that Tesla would not use BTC as a form of exchange. Bitcoin had hit a high of over $60,000. It dropped to below $30,000 soon after the news before moving up again. It means that many traders lost their trading positions if they were day trading.

When trading futures, such occurrences are minimized. A set price is already determined, meaning that a trader cannot be removed from the crypto market suddenly. Therefore, the level of investor protection brought by futures is high.

·       Provides risk management

Many traders are afraid of buying BTC because of the unexpected future risks. Using futures is a form of guarantee against unexpected risks.

Risks of Futures Trading

Here are some of the associated risks of futures:

·       Expiration dates

There is an expiration date with future contracts. This isn’t necessarily a bad thing. However, the price of the commodity can become less attractive nearing the end of the contract. Take the example of a previously mentioned example of Tesla’s refusal to accept BTC. If an expiration date was around that time, then an investor would have lost.

·       No control over future events

You cannot control what will affect the crypto market in the future. The prices of a cryptocurrency are determined by various factors including unforeseen future events. This means that you can lose money if future events go against your predicted events in the crypto market.

·       Leverage issues

The prices can go up and down in extremes when there is high leverage. Therefore, it becomes an issue for investors.

How Profitable is Bitcoin Futures Trading?

As earlier mentioned, bitcoin futures can be very profitable. Since it involves a fixed price, a trader can survive the daily or weekly fluctuations. Some of these fluctuations are temporary and the price of bitcoin will stabilize.

Figure 1 shows an example of a typical price fluctuation of BTC from 2016 to 2018. It is in 2017 that bitcoin futures were introduced in the cryptocurrency market. Apart from providing stability, futures could also make one gain lots of profits.

Using the same graph, take the example of a trader in June 2017 who entered into a BTC futures contract to sell BTC in January 2018. In 2017, the estimated price was about $2,500. However, in January 2018, the price was around $14,000. This would mean result an approximated profit of about $11,500. Therefore, you can make money using trading BTC futures.

Who Should Trade Bitcoin Futures?

Bitcoin futures is a pro instrument. It is one of the cryptocurrency involvements that need a concise trading strategy. If you are a pro trader, it would be easy for you to understand the crypto market and how to bet correctly to gain on the contract’s expiry date.

However, you should know that the crypto market is open for anyone to trade bitcoin futures. But you should at least start with a demo account if you are a beginner here. This will help you understand how it is done.

What to Consider Before Trading Bitcoin Futures?

Whether you are a beginner or a pro, you must consider the following factors:

Leverage Trading

Leveraged trading is the ability of a trader to boost profit potential. The trading platform gives you access to BTC that you do not have to maximize your trading potential. It is exciting because it offers great winning potential. But the risks are also similar.

A beginner trader should start trading with a minimal leverage level. This would give them an increased winning potential but not to an extent that they risk losing a lot of BTC.

Liquidity Assessment

Liquidity assessment is all about looking at the trading volume of BTC. When doing an assessment, traders should look at how the market reacts to the digital asset. High liquidity means that bitcoin is likely to be stable in the future.

Hedging

Hedging is a risk management strategy used in cryptocurrency trading. When you are hedging, you take the opposite position in a related asset to reduce risk. Hedging provides a reduced risk of losing bitcoin. It also reduces the potential of profits.

Diversification

This is a risk-management technique used in the crypto market to reduce the chances of losing cryptocurrencies. Diversification involves opening multiple positions with different digital assets. For example, you can open a position with bitcoin, ethereum, and litecoin.

The concept behind diversification is to ensure that you don’t lose if your main coin plunders.

Market volatility

If the market is highly volatile, high risks are presented. But the risks can also come with great opportunities. It is a factor used by day traders who want to speculate on price movements. The cryptocurrency market is not as big as forex and stock. It can be affected greatly by events in the financial industry.

Expiration Date

When you have trade bitcoin futures to be settled in cash, you must know when the expiration date is. This is when you will be paid cash in exchange for the bitcoins. But you should also know that you can sell an open position before this date. The spot price will determine how much you get paid if you settle before the expiration date.  

Commodity vs. Crypto Futures: Similarities & Differences

There are some common things commodities and futures share. Check out these similarities and differences to understand them better.

Similarities

Both in cryptocurrency and commodities, futures don’t involve the underlying assets. They have different derivatives and prices.

They both have an expiry date and an established contract with settlement terms.

Differences

If you take the example of perpetual contracts, you will notice that they don’t have an expiry date. This is quite different from commodity futures, which must have an expiry date. In terms of volatility, a cryptocurrency is more volatile compared to a commodity.

One major difference is that cryptocurrency futures are traded for speculation and commodities have a defined reason. If you take an example of a gold trader who would buy futures not for speculation but for reserving its price.

Where to buy bitcoin futures?

If you are looking for where to buy bitcoin futures, you have many options. Of course, Chicago Mercantile Exchange (CME) would be your first stop. Another option would be the Cboe Options Exchange.

The only reservation that you should be aware of is the limitations of trading futures in such exchanges. If you are a beginner, you can’t access such futures markets because of many restrictions. CME doesn’t allow non-certified traders to invest. They also have high fees that are discouraging to some investors in the cryptocurrency market.

Key takeaways on bitcoin futures trading

ü  Bitcoin futures can be profitable if you learn how to do it right

ü  Choosing the right trading account should be your first consideration

ü  Always understand the market factors before investing in cryptocurrency futures

ü  Dedicate time researching about bitcoin and futures contract

ü  Use a demo account to familiarize yourself with futures

ü  When trading futures, don’t use high leverage.

FAQ

Here are some of the frequently asked questions:

1.     How similar/different are bitcoin futures to commodities futures?

They both have an expiry date on which the contract value is paid. The main difference is that volatility, which is higher in bitcoin than in commodities. Some bitcoin futures like perpetual contracts also don’t have an expiry date, which differs from commodities that have a fixed date.

2.     Am I eligible to trade bitcoin futures?

Yes, you can trade bitcoin futures. You just need to identify a suitable trading platform to get started. You should note that some brokerage platforms like CME don’t accept traders who are not yet licensed. This means that you might have a limitation to trade bitcoin if you choose such platforms.

3.     What special considerations should I take into account before trading bitcoin futures?

There are six factors that you need to consider before you start trading futures. They include leverage trading, liquidity assessment, hedging, diversification, market volatility, and expiration date.

4.     What are the transaction fees for Bitcoin futures trading?

The transaction fees of futures vary from one broker to another. that has among the lowest minimum deposit and low fees to get you started.