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.
What Are Cryptocurrency Futures?
The “contract specifications” of futures define the product that is traded. The basic components of a futures contract are:
- Underlying Asset
- Date and Time of Expiry
- Mode of Settlement (Cash or Physical)
- Contract Size
- Type of Futures Contract (Vanilla or Inverse)
- Tick Size
There are two ways of settling a futures contract — cash-settled or physical delivery.
Cash-settled futures require a spot price index to determine the settlement price. In this way, no underlying asset changes hands. Instead, the profit and loss is calculated from the trade price to the settlement price, and parties are credited/debited on their trading accounts accordingly. Examples of exchanges that are cash-settled are BitMEX, OKEx and CME.
Physical delivery futures requires the buyer to buy the underlying asset from the seller at expiry. This implies that the seller must own the underlying asset at expiry for the purposes of delivery. Examples of exchanges that mandate physical delivery are Bakkt and CoinFlex.
Contract size differs from contract to contract. The contract size for CME Bitcoin futures is 5 BTC, while the size for Bakkt Bitcoin Futures is 1 BTC. Do read the contract specifications before trading!
There are two types of futures contracts in the space — vanilla and inverse. A vanilla futures contract has its contract size in the base asset, for example**, 0.1 BTC in a BTC/USD** underlying. An inverse futures contract has its contract size in the quote asset, for example**, 1 USD in a BTC/USD** underlying. The inverse futures contract is most apparent on exchanges that calculate profit and loss in BTC terms – BitMEX, OKEx, Deribit, etc.
Tick size refers to the small price increment of the contract. For example, BitMEX has a $0.50 tick size for their futures, while CME has a $5 tick.
The hotly anticipated launch of Ethereum futures by the Chicago Mercantile Exchange has seen the price of Ether soar to new heights. Although trading was slow at first, it’s hoped that this move by a leading, regulated derivatives marketplace will enable institutions to expand their outlook beyond Bitcoin — and speculate on ETH’s value without having to own the asset. Crucially, as well as betting that the value of Ether can go up, traders can have the opportunity to short the altcoin if they so wish…presenting opportunities when the market is overheated.
There has since been speculation that the debut could negatively impact Ether’s price. Famously, Bitcoin broke $20,000 for the first time in 2017 at the same time as BTC futures arrived — with prices tumbling by an eye-watering 80% in the year that followed. Not everyone subscribes to this view — and many commentators have predicted that ETH futures are a bullish development, and could pave the way for options in the future.
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.
How Do Bitcoin Futures Dates Work?
New Bitcoin futures contracts are launched each month, with an initial set price for those contracts pre-determined before trading begins. Each contract has a specified expiry date of three months in the future. For example, a contract created in January would have an expiration date in March.
Most contacts aren’t held until their expiry date, as they’re traded just like other assets. However, if the futures contract reaches its expiry date, a trader has a legal obligation to deliver on it.
When the Bitcoin futures date is coming up a trader has three options — they can either offset, rollover or let the contract expire.
Bitcoin futures expire on the last Friday of the contract month, and are settled with cash rather than BTC itself. Depending on whether you held the long position (the buyer) or the short position (the seller,) you would need to sell or buy at the agreed price, regardless of the current price of Bitcoin.
How to Buy Bitcoin Futures
Buying Bitcoin futures isn’t for the faint of heart — and it’s normally a space that’s reserved for the seasoned hedge fund manager and large financial institutions, who wouldn’t break a sweat should they lose $15,000.
However, the volatility of the market can see those with deep pockets take advantage of the opportunities that the ups and downs of Bitcoin can bring.
If you want to know how to buy Bitcoin futures, you’ve got two options. The first option is to go via a regulated futures exchange such as the CME Group, which was one of the first exchanges to bring Bitcoin futures to institutional investors.
The second option for buying Bitcoin futures is to go via an exchange, which is becoming increasingly popular with the retail investor. These types of trading platforms don’t need to jump through as many regulatory hoops to get going…and they can also be a lot more responsive to user feedback. Notable exchanges offering these derivatives include OKEx, Huobi and Binance. They also have a slightly different model for delivering futures contracts, so it’s worth checking out all your options.
Much like Bitcoin, Litecoin is a peer-to-peer cryptocurrency that is built on blockchain technology. The team at Litecoin used Bitcoin’s project code and modified it to create this cryptocurrency.
When Litecoin futures were launched, they gave investors more options to access the crypto market without having to hold any crypto assets, much like Bitcoin futures. The contracts come with shorter expiration dates than Bitcoin futures — and can even be weekly or monthly in some cases.
Trading in Litecoin futures gives you leverage and can allow you to make a profit should you go long (buy when the price is low) and benefit from a price increase, or go short and sell when the price is high. If you were to spot trade LTC, you could either trade and suffer losses should the price fall or wait for the price to hopefully increase again.
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!
This piece was updated on Feb. 25, 2021 to include the latest information on Ethereum, Bitcoin and Litecoin futures.