Crypto futures allow investors to bet on the future price of bitcoin without having to possess or handle the currency. A derivative trading product is a futures contract. These are regulated trading contracts in which two parties agree to buy or sell an underlying asset at a predetermined price on a specific date. The underlying asset in the case of bitcoin futures would be bitcoin.
Futures allow investors to protect themselves against turbulent markets by ensuring that they will be able to buy or sell a specific cryptocurrency at a specific price in the future. Of course, if the price changes in the opposite direction, a trader may find up paying more for bitcoin than the market price or selling it for a loss.
In some cases, rather than directly buying or selling a cryptocurrency like bitcoin, which requires setting up a crypto wallet and navigating through intricate exchanges, investors can use futures contracts to obtain indirect exposure to bitcoin and perhaps profit from its price moves.
In late 2017, the Chicago Board Options Exchange (CBOE), currently known as the Cboe Options Exchange, introduced regulated bitcoin futures trading, which was quickly followed by contracts on the Chicago Mercantile Exchange (CME). While the Cboe product is no longer available, CME futures have become a significant part of the crypto trading market. The rolling 24-hour notional value of all futures contracts across major exchanges in the United States and internationally was $26.9 billion on February 16. The notional value of bitcoin is calculated by multiplying the price of bitcoin by the number of futures contracts purchased by investors.
CME reported a daily average volume of 10,105 bitcoin futures contracts in 2021, up 13% from the previous year.
How does cryptocurrency futures trading work:
A crypto futures contract has three essential components.
- The expiration date is the deadline for the futures contract to be settled. To put it another way, one party must buy and the other must sell at the agreed-upon price. Traders can, however, sell their contracts to other investors before the settlement date if they want to.
- Units per contract: This metric determines how much each contract of the underlying asset is worth, and it varies by platform. One CME bitcoin futures contract, for example, is worth 5 bitcoins (denominated in U.S. dollars). On Deribit, however, one bitcoin futures contract equals ten dollars worth of bitcoin.
- Exchanges allow users to borrow funds to raise their trading size, which increases the possible gains a trader can make on their futures bet. Leverage rates vary widely between platforms once again. Kraken users can leverage their transactions up to 50x, whereas FTX’s leverage rates have been cut from 100x to 20x.
Futures contracts can potentially be settled in two separate ways.
Physically delivered: The buyer buys bitcoin and receives it after the transaction is completed.
Cash-settled: When a transaction is completed, the buyer and seller exchange cash (typically in US dollars).
Pricing for cryptocurrency futures
Although the price of a crypto futures contract is designed to closely reflect the price of the underlying commodity, its value can fluctuate over time (as it edges toward its settlement date). This is frequently produced by abrupt significant fluctuations in volatility, which might be triggered by a fundamental stimulus like Tesla buying more bitcoin or a big country outlawing cryptocurrency. Spreads can expand or narrow in one or more sets of futures contracts compared to others due to supply and demand difficulties for individual contracts.
Other price fluctuations include what are known as “gaps.” These are periods of time on price charts when no trade is taking place, so no pricing data is available for such periods. They’re only available on traditional platforms like CME because they have set trading hours, unlike the wider crypto market, which is open 24 hours a day, 7 days a week.
When the market reopens the next day after a cryptocurrency’s price has jumped dramatically during typical market closing hours, big gaps in the asset’s price chart on a traditional platform can occur.The popularity of crypto-based futures products has exploded in the previous five years, and there are now a slew of traditional and crypto-native platforms where you may start trading crypto futures.
What is the difference between perpetual swap contracts and futures contracts?
If you’ve been around the crypto world long enough, you’ve probably heard the term “perpetual swap contract.”
Perpetual swaps, sometimes known as “perps,” are similar to futures contracts in that they allow investors to buy or sell an underlying asset at a future date, but they have one major difference: they have no expiration date.
This means that a trader can keep their buy or sell contract open for as long as they want – as long as they keep up with margin payments – until they’re ready to settle or sell it to another trader.
Because these trading contracts have no expiration date, a particular technique is required to ensure that the contract price closely reflects the spot price (current market price). Long (buyers) or short (sellers) traders pay the opposing party a recurring charge, based on whether the contract’s price is above or below the market price.
Long traders will be compelled to pay a fee to short traders if the market price is lower than the perp futures price, in order to dissuade more traders from going long. Short traders will pay a fee to long traders if the market price is higher than the perps futures price.
Perp funding rates are a valuable statistic for determining market sentiment about a specific asset.
The Risks of trading crypto futures
Despite the many advantages of trading futures over spot trading (buying and selling assets with immediate delivery), such as indirect exposure and trading with leverage to increase possible gains, novice investors should be aware of a number of major hazards. The majority of these are margin calls and liquidations.
Trading using leverage, as previously said, entails borrowing cash from a third party, usually the exchange you’re trading on, in order to enhance the size of your trade.
Naturally, an exchange will not allow you to borrow funds unless you provide some form of protection in the event that the deal goes against you. This safety net is referred to as a “initial margin,” which a trader must set aside before engaging in a leveraged transaction. Leverage increases your potential gains while also increasing your losses.
But before we do that, it’s crucial to grasp three critical aspects of a futures trade:
Account: The initial margin is held in the margin account (the minimum amount of collateral required to open a futures trade).
Margin calls: When an exchange tells a user that the capital in their margin account is getting low, this is referred to as a margin call.
Maintenance margin: This is the amount of money that a user needs to have on hand in case their initial margin runs out. Consider it a safety net.
When the market swings against a trader and their margin account is exhausted, they are subject to “liquidation,” which means the exchange will immediately liquidate your position and seize your initial margin.
The general formula for calculating how much the market has to move against you before you’re liquidated is: Liquidation percent = 100/leverage. If you are leveraged 50 times, for example, the market only needs to move against you by 2% to liquidate your position (100/50 = 2). That implies you run a very high chance of getting liquidated and losing your invested funds in the highly volatile crypto industry.
Of course, investors can always increase their initial margins to keep their positions open for longer in the hopes that the market would move in their favour, but this increases capital risk.