What Are Futures?
In simplest terms, futures are a financial contract wherein two parties agree on the price of an asset in the future. For example, we both agree that I will pay you $10,000 next week for one Bitcoin, even if it’s price by then is at $20,000 — because it could just as easily be at $4,000.
In fancier terms, futures are a form of financial derivative contracts that creates an obligation for two parties to trade the underlying asset for an agreed-upon price at a predetermined time (date of expiry). At expiry, the buyer is obligated to buy the underlying asset from the seller at their trade price, and the price of the underlying at expiry is irrelevant.
This makes futures contracts extremely effective for hedging future price risk, as parties can lock in a suitable price in advance of delivery. This means that miners can estimate how much Bitcoin they could potentially mine in the future and sell the futures contract in anticipation of their output. This allows them to capture favorable prices for the Bitcoin, which they have not yet mined.
How Are Bitcoin Futures Priced?
The Bitcoin futures price is multifaceted. Whilst it might be simple to think that it follows the spot price of Bitcoin, the quoted sum is a combination of the perceived volatility of Bitcoin itself and price arbitrage. Generally speaking, the price of futures track the price of the underlying asset.
Bitcoin futures price modeling is based on a cost-of-carry framework, which is related to the costs that are linked with carrying the value of the investment.
Whilst theoretical calculations should mean that Bitcoin futures follow the spot price, those in the market account for volatility and real-world crypto developments. The spot price can soar and fall again — sometimes within hours — and the ability to trade crypto 24/7 also has an impact on pricing. The spot price will always reflect what’s happening around the world with Bitcoin — meaning a dramatic announcement such as a country banning BTC will have percussions in its value. Futures pricing can be a guessing game as it is subject to so many variables.
How Popular Are BTC Futures?
Since Bitcoin futures first made an appearance back in December 2017, they’ve been a hit — allowing traders to maximize crypto gains without holding the underlying asset. This proved particularly popular for those that couldn’t trade in cryptocurrencies due to regulatory matters. The introduction of Bitcoin’s futures initially led to a 10% increase in the price of Bitcoin.
Bitcoin futures, explained simply, are a contract between two parties that agree to sell or buy Bitcoin on a set date, for a set price in the future. They are deemed as a good development for the crypto world, as they’ve introduced liquidity into the market, and it allows investors to speculate on the future price of Bitcoin without actually owning any. They’re also seen as beneficial to the miners as they can hedge against fluctuations and plan their cashflow.
Due to the volatility of the crypto market, there are big opportunities to make a profit. Investors are attracted to Bitcoin futures because they can short (or speculate) on regulated exchanges.
Why Do Traders Trade Cryptocurrency Futures?
Most cryptocurrency futures exchanges allow traders to utilize leverage in the trading of futures. This means that the trader does not need to have collateral equal to the size of their position — they can use a smaller account to control a larger position. This creates flexibility for the trader to size their positions and extends the use of available capital. However, leverage is a double-edged sword. Having too much leverage creates the risk of liquidation on the position or the account if prices move adversely against the position. Bitcoin is a volatile product, so watch your leverage!
When trading on spot markets, every bid and ask represents actual assets that must be available. A seller needs to own the underlying asset before placing an offer, and the buyer needs to own the underlying capital (USD, USDT, etc.) before placing a bid. When trading derivatives like futures, contracts are created and backed by margin requirements. Hence, traders can place larger orders (see leverage), creating liquidity in the derivatives market that is not seen in spot markets.
Given the ability to use great leverage and access to high amounts of liquidity, traders that require a hedge for their position of BTC prefer using futures instead of spot. Think of the miner that can project his estimated output in BTC or the payment processor that knows he will be receiving BTC in the future. Both these parties want to hedge price risk of the asset before they receive the asset. As you cannot sell something on the spot market that you do not yet own, these traders will turn to the futures market to execute their price hedge.
Cryptocurrency futures exchanges allow users high amounts of leverage — up to 100x. This allows users with smaller accounts to control larger positions, allowing for greater rewards when the trade is right. However, leverage is a double-edged sword. An overly leveraged account is never a good idea. Understand the risks before you execute trades on leverage!