What are Bitcoin Futures?
In short, the cryptocurrency futures are financial instruments used to trade coins at a pre-conditioned price and on a specific date. The idea of the Bitcoin futures is not new: future contracts trading exists on the stock and commodity markets, too. Thus, when the Nasdaq index moves up and down, the traders buy and sell the stock and the stock futures.
Since Bitcoin is the most used cryptocurrency, Bitcoin futures are the most widespread cryptofutures. Like stock futures contracts, the traders use the Bitcoin futures to speculate on the future cryptocurrency price. The volatility on the cryptomarket is higher, so the successful trader can make a significant profit on this asset.
The Bitcoin futures are the derivatives, the assets that follow the underlying one, existing in the form of contracts. Two entities form a specific agreement (contract) to buy or sell an asset – in this case, Bitcoin. The contract then follows the primary cryptocurrency asset.
Getting into a cryptocurrency futures contract is a lot like betting. This way market participants can gamble with their understanding of the trend. If they wager correctly and the future asset price matches their estimates, they win. If the estimates fail to match the price, the trader loses money.
There are two basic options for those wishing to purchase cryptocurrency futures: “long” option, implying the expectancy of price growth, or “short” option, when the trader expects it to decrease. If you buy long, you must specify the date of cryptocurrency asset purchase and vice versa. Whatever happens to the asset price, the contract will be fulfilled and closed on the specified date.
There is also a possibility to use leverage for some cryptocurrency futures. Leverage is the specific term in trading, and it means the use of the credit from the brokerage company. In that case, traders can borrow some funds to bet with the futures contracts. Leverages are usually very profitable to use and offer access to larger futures options. However, they can also be dangerous in case the deal turns out unsuccessful.
If a trader uses leverage, there is no need to fund the full amount required for the contract. Leverage allows purchasing futures with a much lesser initial capital (also known as initial margin). If the cryptocurrency price goes against the trader’s expectations, a certain level of “maintenance margin” should be maintained, so that the position stays open. If the price surpasses this level, the position goes down. The size of leverage for futures purchasing is individual for each exchange.
How does futures trading work?
As we have already established, cryptocurrency futures traders can get money from speculation on Bitcoin prices, without the need to purchase Bitcoins themselves. We have also defined two ways of futures trading, going long and short. Now we will describe those methods in more detail.
Going long (buying futures)
The primary object in the Bitcoin futures trading is a contract, which can change owners several times during its lifetimes, from the moment of opening and till it expires. Market changes constantly, and cryptocurrency traders try to adapt to changes in selling and purchasing contracts according to the price of Bitcoin.
Let’s make an example. A cryptocurrency trader has decided to make several trades with Bitcoin futures. All deals are scheduled between March 1s and April 1st. In this period, the trader can enter a Bitcoin futures position at any moment and any price at the time of purchase. After that, he or she can sell the futures any time before April comes, and the contract expires. The gains or losses depend upon the overall change in Bitcoin price.
To make the example more specific, let’s assume that our trader buys a futures contract at $2,900 on March 9th and sells it on March 11th for $3000. He will receive a profit of $100. However, if the price goes the other way, decreasing down to $2800, our trader will have no option than to sell it at that price and lose $100.
Going short (selling futures)
Another option available for the trader is to sell cryptocurrency futures short. Doing that means that the trader expects Bitcoin price to decrease in the future. If our trader sells a futures contract short, he or she would “borrow” someone else’s futures contract and sell it, expecting that the price drops and he or she can repurchase the contract cheaper. The price difference would make our trader’s profit in this case. Bitcoin traders use cryptocurrency exchanges for such operations to avoid seeking contracts themselves and save time.
Another example: let’s assume that the Bitcoin price on March 8th is $2800. The market expects it to drop further to $2200 by March 15th. Our trader is going to sell futures short contracts using cryptocurrency exchange special features. Let’s say the price really dropped to $2200 by March 15th, and our trader sold his contract at $2800. Here, the profit will equal $600, after the trader repurchases the contract.
In the example above, we should emphasize that it is possible to close the position whenever the trader wants before the expiration date on March 15th. If the trader sold the short contract at $2800 on March 8th, but the price has dropped even lower, down to $1800, the trader can buy back the contract earlier, completing the trade and getting a profit of $1000. If the price goes against expectations and rises up to, say, $3500, and the trader cuts the trade, the contract will be over. In this case the trader will suffer $700Q in losses.
Read more How to Avoid Bitcoin Scams?
Bitcoin Futures trading basics
The Bitcoin futures are attractive for the traders because they can be more beneficial than the direct purchasing of Bitcoins. The major problem for traders who wish to purchase Bitcoins is its rather complicated system of storage. The futures trading eliminated this problem. The exchange usually provides a safekeeping service for the traders. Besides, many cryptocurrency futures contracts end up being settled in cash. So the issue of custody becomes completely irrelevant. The market of Bitcoin futures trading is also attractive for institutional traders since they usually prefer dealing with derivative products. Despite all the differences between crypto exchanges and traditional markets, the futures trading principles are the same.
Hedging is another way of usage for Bitcoin futures. If the trader deals in Bitcoins, a futures contract in reverse position can be an excellent way to mitigate some amount of price fluctuation risks.
The futures contracts are also a right way for Bitcoin traders to get acquainted with the cryptocurrency market. The losses they might suffer are initially integrated, and any collateral damage is anchored when they enter a position.