What are Bitcoin Futures: Trading on a regulated market

How it works

Speculating on Bitcoin price movements

Bitcoin futures are used to bet on future price movements either to hedge spot market positions or to benefit from both growing and falling market trends without actually owning the underlying asset.

Let’s suppose you expect that the price of Bitcoin will grow. To buy a futures contract, you have to provide marginal collateral in the amount of 50% from the contractual value, pay a brokerage fee and exchange fee from $15 to $30 depending on the trading venue.

If the Bitcoin is higher than your futures contract price agreement, you can profit from the surplus. However, if the Bitcoin’s exchange rate goes down, you’ll incur substantial losses as you will have to pay out the difference and maintain the collateral at the required level.

Speculation on futures price fluctuations

Apart from betting on the way the market for an underlying asset product is going to move, investors can profit from trading futures contracts during their lifetime before expiration. While the price of a futures contract is based on the value of the underlying asset, it may vary depending on the cost of the asset specified in the contract and on the sentiment of the spot market.

Bitcoin Futures Contract Specifications

Large trading venues, like CME and CBOE, set rather high market entry barriers, affordable mostly for wealthy individuals or institutional investors. Currently, CME offers two-month future contracts for 5 BTC with minimum price fluctuation $5 per Bitcoin or $25 per contract and maintenance margin 50%.

The futures price is based on the Bitcoin Reference Rate (BRR) – an aggregated rate across major bitcoin spot exchanges between 3:00 p.m. and 4:00 p.m. London time. As they are financially settled, no real Bitcoins are involved. It means that traders can profit from Bitcoin’s price movements without actually owning an asset. CBOE offers Bitcoin futures for 1 BTC with similar trading conditions.

Bitcoin futures benefits

Despite some controversy, these instruments bring a lot of improvements to cryptocurrency markets.

Price transparency

Bitcoin futures contracts are settled every trading day, based on transparent reference price, reflected in all Bitcoin-related contracts. Unified price reference mitigates the volatility of spot prices, making Bitcoin suitable for payment purposes.

Regulation

This is probably one of the most touted and most controversial advantages of Bitcoin futures contracts. Hardcore crypto fans believe that the regulatory environment kills the libertarian nature of cryptocurrency that was born to be free, but the majority of market players are sure that regulation is a necessary step to Bitcoin mass adoption. The futures markets are regulated by Commodity Futures Trading Commission (CFTC), which is not as strict as SEC in terms of oversight. It sets the rules to be observed by all participants, ensuring equal opportunities for investors and speculators, fraud protection and predictability.

Institutional money and enhanced liquidity

Most Wall Street firms and investment funds will not touch anything that is not regulated, while futures offer them an easy way to get involved in operations with digital assets. It means that in the long run, these regulated instruments will attract professional players on the market, increasing the liquidity of both futures contracts and Bitcoin itself.

Leveraged trading

Leverage allows trading many Bitcoins while paying only a portion of the real price. It makes futures trading more appealing to investors as they don’t have to pay the full cost of the asset to profit from the price movements. At the same time, it makes trading riskier and may cause significant losses if a trader gets it wrong.

Short selling

Bitcoin futures provide traders with the instrument to short sell, that is to bet on price fall without actually owning the asset. It unlocks investment opportunities for crypto skeptics, namely for those who don’t have Bitcoins, but believe that the price will go down.

Bitcoin futures risks

However, there are a couple of flies in this ointment, or risk factors to be considered by potential investors.

Risks of losses

Bitcoin futures are considered to be highly risky instruments due to potentially significant losses. If you are wrong with your price forecast, your money will flow out of your pocket right to the trader who got it right. Considering leveraged trading and highly volatile nature of cryptocurrency markets, the losses may be substantial.

Both CBOE and CME try to mitigate the risks with so-called price limits of 7%, 13% and 20% They are applied both to upside and downside movements relative to the prior day’s Bitcoin futures settlement price. Basically, it means that the exchange freezes the price for two minutes if it goes 7 or 13% up or down and won’t allow it to change it more than 20% on a daily basis.