What Are Bitcoin Futures And How Do They Work: Simple step-by-step guide
Bitcoin Futures vs Bitcoin CFDs
Bitcoin futures were first traded in the United States at the Chicago Mercantile Exchange (CME) in December 2017. Three years later, they have become one of the most popular crypto derivatives.
They have curved a multi-billion niche in the crypto industry and sparked interest from the leading crypto exchanges and brokerages. They want in on the niche that, though it still is in its nascent stages, promises to be quite lucrative.
But how profitable is the Bitcoin futures trade? Importantly, where do you trade BTC futures, and how do you buy your first BTC futures contract?
We answer these and more questions in this Bitcoin futures guide. But first, you need to understand what bitcoin futures are and how they work. Who can trade bitcoin futures, what are the benefits and risks of the trade, and what is the difference between BTC futures and such other BTC derivatives as options and CFDs?
We clear all this and tell you everything else you need to know about BTC futures trading in this Bitcoin futures trading guide.
What Are Bitcoin Futures?
Bitcoin futures is a form of Bitcoin derivative trading that involves speculating on the future price of Bitcoins. It is a bet placed via a binding contract between the buyer and seller, obliging either party to buy or sell Bitcoin to the other at a specific future date and at a predetermined price.
The contract is a binding legal agreement that requires the parties to execute the trade upon expiry of the contract, regardless of whether the price has risen or fallen.
Types of Bitcoin Futures Contracts
There are three primary types of Bitcoin futures contracts that you need to familiarise yourself with, including:
Standard futures contracts
These can also be referred to as the traditional futures contracts as they have all the features of the conventional futures contracts used to trade different trading instruments.
A standard futures contract stipulates such factors as the BTC price and expiry date. This kind of BTC derivative was first floated on the CME on 10th December 2017 and is settled in cash (USD).
Perpetual contracts mirror all the attributes of the standard bitcoin futures contract- safe for the expiry date. As the name suggests, the contracts are perpetual – that they do not have an expiry date. Instead, they are looped into an endless cycle of funding that occurs after every eight hours.
Looking at how a perpetual contract works from a standard contract’s point of view, you may consider the eight hours to be the expiry date – during which time the contract is settled. But instead of closing/ending the futures agreement as is the case with standard futures contracts, it is automatically renewed for another eight hours. This cycle continues until you terminate the contract.
The perpetual Bitcoin futures contracts were first introduced by the BitMex exchange, which also set the eight-hour loop that has now become an industry standard. Like the standard contracts, Perpetual bitcoin futures are settled in cash (USD).
Futures with physical delivery
Bitcoin futures with physical delivery works like any other standard futures contracts – safe for the mode of settlement. They have a predetermined price and expiry date, but unlike the standard and perpetual contracts that are settled with cash (USD), these involve the transfer of actual bitcoins from buyers to sellers and vice versa – hence the term ‘physical delivery.’
This form of Bitcoin futures trading was first introduced by BAKKT – a trading platform that is a subsidiary of the Intercontinental Exchange (ICE).
How Do Bitcoin Futures Work?
To trade Bitcoin futures contracts, you first need to approach your preferred exchange or brokerage. Open a Futures trade by specifying whether you are going long (BUY) or shorting (SELL) the bitcoin price. Set the expiry date of the contract – typically three months – and then wait.
When the expiry date is hit, you will be required to buy or sell the Bitcoins (USD equivalent in case of standard and perpetual contracts). Whether you profit or lose cash in the trade is largely dependent on the accuracy of your prediction.
Here is an example of a standard Bitcoin futures trade:
It is April 2021, and Bitcoin is trading at $59,000.
Scenario 1: If you expect that Bitcoin spot prices will continue with their upward trajectory, you could choose to long/buy the Bitcoin futures contract at the current price of $59,000. Let's assume it has an expiry date of 4th July 2021.
If your BTC price prediction is correct and the Bitcoin value rises to $65,000, you can sell the contract, effectively making a $6,000 profit. However, if Bitcoin prices fall to $54,000, you will suffer a $5,000 loss upon selling the contract.
Scenario 2: If you expect that Bitcoin spot prices will fall to $50,000, you can choose to short/sell Bitcoin futures contracts at the current price.
Assuming that you are right and BTC spot prices plunge by 4th July 2021, you can buy back the bitcoins position, effectively making a $9,000 profit. However, should the markets defy your analysis and BTC spot prices soar to $70,000, you will have made an $11,000 loss upon buying back the position.
Who Can Trade Bitcoin Futures?
Virtually anyone that is looking to make money from speculating on Bitcoin’s price direction without actually owning the Bitcoins can trade Bitcoin futures contracts.
You nevertheless have to keep in mind that futures contracts trading involves a lot of accurate predictions of Bitcoin’s future price. To succeed here, therefore, you need to have mastered the different price analysis techniques.
It is also worth considering the fact that Bitcoin futures trading falls in the medium-term investment category and, therefore, appeals most to swing traders.
What You Need to Know Before You Start Trading Bitcoin Futures
Here are some of the most common terms and concepts used in Bitcoin futures trading. You need to familiarise yourself with each before you can start trading bitcoin futures.
Strike price refers to the value or price that the crypto traders believe Bitcoins will hit by the time your futures contracts expire. Here is an example, if you enter into a futures contract whose expiry date is three months down the line, Stripe Price here refers to the price of bitcoins at the time of ending the contract.
We mentioned that the two primary aspects of a standard Bitcoin futures contract are the predetermined buying/selling price and the predetermined execution date. Traditionally, futures contracts last three months and are executed on the third Friday of the third month. This is the bitcoin futures expiry date – the date on which the buy/sell agreement must be executed. The liberalization of the markets has, however, made it possible to have bitcoin futures with shorter durations – up to 1 week.
Going long or short
Going long on a bitcoin futures contract refers to the act of buying the contract with the expectation that its price will rise and its strike price will be higher than the current price. Shorting a bitcoin futures contract or going short, on the other hand, refers to the act of selling
American or European contracts
There are two types of futures contracts: American Style contracts and European-style contracts. American-style contracts are relatively flexible and can be cashed out before the expiry date.
Here is an example: Let us assume you have bought (longed) a Bitcoin futures contract worth $60,000 (in May 2021) for a duration of three months – up to August 2021. But two months down the line, its bullish run skids, and the digital currency start losing value. If it is an American futures contract, you can cash it out in July when the prices have possibly fallen to $55,000 and mitigate further losses arising from a continuous decline in value.
The European contract is, on the other hand, quite rigid. There is no option of cashing out the contract before its expiry date and, effectively, no chance of mitigating unforeseen risks that arise during the life of the contracts.
When looking to buy Bitcoin futures contracts, therefore, first confirm whether they are American or European style. It then goes without saying that you are better off choosing American-style contracts if you hope to mitigate any unforeseeable future risks.
What is the Difference Between Bitcoin Futures and CFDs?
Bitcoin futures contracts and Bitcoin CFDs are speculative investments that allow you to profit from the volatile Bitcoin price movements without necessarily owning actual Bitcoins. Here are some of their key differences:
Expiry date: Unlike bitcoin futures that have a predetermined expiry date, Bitcoin CFDs do not have a specific settlement date. They are more flexible and can be bought or sold at any time.
Liquidity: Bitcoin CFDs are by far more liquid than Bitcoin futures contracts that are by themselves considered to be relatively liquid.
Ease of trade: The Bitcoin futures contracts can be considered prohibitively expensive in comparison to CFDs that you can buy with as little as $1. Typically, Futures contracts on such exchanges as the CME are designed to appeal to high net worth individuals or institutional traders, while CFDs are marketed to retail traders.
What is the Difference Between Bitcoin Futures and Options?
Bitcoin futures and Bitcoin options are both derivatives that allow you to speculate on the future price of the legacy digital currency. They both are traded on Bitcoin exchanges and allow you to earn from Bitcoin’s price movements, without actually owning the actual Bitcoins. But there are several key differences between how Bitcoin futures contracts and bitcoin futures options work:
Obligation to trade
When trading Bitcoin futures contracts, you are under a legally binding agreement that obliges you to buy or sell BTCs at a predetermined date and at a predetermined rate. Bitcoin futures options can, on the other hand, be viewed as conditional where the buyer or seller is given an option to buy or sell BTC if it hits a given price level.
Here is an example: You can buy an option to purchase Bitcoins when their value rises to $65,000. This means that as long as the BTC price is below this strike price, you are under no obligation to buy. We, however, assume that two months down the line, there is positive news that excites the market, and Bitcoin soars to $70,000 overnight. At this point, and only because the strike price has been achieved, you may exercise your option (no obligation) to purchase the BTC at the agreed price of $65,000 – effectively earning a $5,000 profit.
You will need to pay a premium when buying a bitcoin option, this is not the case for bitcoin futures contracts.
Bitcoin futures contracts have a predetermined expiry date, during which time the buying or selling must happen. Bitcoin options, on the other hand, don’t have a specific buy/sell date, and the purchase or sale of bitcoins will only be made when trade conditions are met and at the buyer/seller’s discretion.
The obligation to buy or sell regardless of whether you are making a profit or loss makes bitcoin futures contracts riskier than the Bitcoin options that do not carry the obligation to trade clause.
How to Prepare to Trade Bitcoin Futures
Stage 1: Learn about the different types of Bitcoin futures contracts.
Stage 2: Decide on the type of Bitcoins futures contract you would like to buy.
Stage 3: Decide on the exchange or brokerage to engage.
Stage 4: Register a trading account, verify your identity, and fund the account.
Stage 5: Start trading.
Where to Buy Bitcoin Futures
- The Chicago Mercantile exchange
- Chicago Board Options Exchange
- BitMex exchange
- Binance exchange
- OKcoin exchange
- Kraken exchange
- TD Ameritrade
- BitFlyer exchange
- ByBit exchange
How to Trade Bitcoin Futures
How to buy bitcoin futures on Binance
Step 1: Start creating and funding your trader account on your preferred exchange/brokerage (Binance).
Step 2: From the user dashboard, click on trade and choose to trade either USD-Margined or COIN-Margined futures.
Step 3: Decide if you wish to trade perpetual or fixed expiry date (QUARTERLY) contracts.
Step 4: Customize the trade by deciding whether you want to buy or sell and whether you want to place a limit or market order. Set the BTC price and the number of Bitcoins you would like to buy, decide on the leverage you would like to use (up to 125:1), and set the stop loss and take profit levels.
How to trade Bitcoin futures contracts on CME
Step 1: Start by registering an account with a Futures Commission Merchant (FCM).
Step 2: They will advise you on the best type of account or membership that is appropriate for you.
Step 3: Fund the account.
Step 4: Your FCM will trade these Bitcoin futures on your behalf and provide account-clearing services.
Alternatively, institutional traders can use the CME Direct portal. Individual traders, on the other hand, can only access CME futures via registered futures brokers.
Some of the features of a standard Bitcoin futures contract on CME include:
- A single contract carries 5 Bitcoins [5*$59000 (current bitcoin price)=$295,000].
- Contracts are financially settled (no transfer of Bitcoins involved).
- Contracts last six months.
Note: CME plans to introduce micro-Bitcoin futures contracts valued at 1/10 (one-Tenth) of Bitcoin price starting 1ST May 2021.
Bitcoin Futures Contracts Trading Tips
Master technical and fundamental analysis: To accurately predict the future price of Bitcoin and decide on whether to long or short a trade, you need to learn how to analyze the digital currency’s technical and fundamentals.
Start small: Create a futures investment strategy that involves starting small and committing more capital gradually as you gain experience.
Consider risk management: You also need to learn how to manage and mitigate futures investment risks.
Go slow on leverage: Learn how to interact with leverages as they have the potent of subjecting you to heavy losses.
Stay alert about the crypto industry happenings: Monitor the news, follow news sites on social media platforms and keep tabs on the crypto calendar. They all report on industry happenings that may affect Bitcoin prices.
Only trade on reputable platforms: Avoid phoney futures platforms and only trade on reputable futures exchanges and licensed brokers.
Join Bitcoin futures trading communities: Join online crypto trading communities and forums where they share Bitcoin trading tips.
Set your investment goals straight: You can avoid investment killers like FOMO and other forms of emotional trading only by having a solid investment goal and sticking to it.
Check Out: Bitcoin Trading Tips to Follow
Benefits of Trading Bitcoin Futures
✅ Trade any market direction: Bitcoin futures contracts make it possible for you to trade any market direction. It allows you to go long on a trade when you expect the BTC price to go up and short the futures contract when you expect Bitcoin prices to fall.
✅ Cash-out anytime: Liberalization of the futures markets has made it possible for you to transfer or cash out on bitcoin futures as a risk mitigation measure. The ability to cash out on a futures contract before its expiry date is, however, not available to European-style futures contracts.
✅ Access to leverage: Bitcoin futures trading platforms give their clients access to relatively high leverages. Finance, for instance, gives retailers access to leverages of up to 125X, which ensures you can make tangible profits even with small trading capital.
✅ Cash settlement: You do not have to invest in a wallet or worry about losing your Bitcoins when trading futures contracts because they do not involve actual bitcoins. When trading bitcoin futures contracts, you are only speculating on the price of bitcoins and not buying the actual crypto.
Risks of trading bitcoin futures
❌ Relatively risky – Bitcoin Futures contracts rank high on the list of the riskiest cryptocurrency derivatives.
❌ The threat of price squeezes: The crypto industry is still in its nascent stages, and this exposes it to such threats as short squeezing and market manipulation from major Bitcoin holders, which may negatively affect the performance of your Bitcoin futures contracts.
❌ Volatility: Bitcoins is also one of the most volatile investment products. This, plus the fact that there is hardly enough data to inform fundamental research, makes its untamed volatilities and market swing a threat to bitcoin futures traders.
Final word: Should You be Trading Bitcoin Futures?
Well, there is no blanket answer to whether you should be trading Bitcoin futures today? Only you can determine whether the ultimate reward from the investment is worth the risks associated with the investment product.
To arrive at this conclusion, you will need to assess your trading skills, your experience with crypto trading, and your risk tolerance levels. Importantly, you have to open up your mind to new Futures trading ideas and commit to never stop learning.
In the above, Bitcoin futures guide, we have looked at everything you need to know about trading BTC futures contracts, where we emphasize on risk management and proper research before you embark on the trade.
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Virtual currencies are highly volatile. Your capital is at risk.
Is Bitcoin futures trading profitable?
Yes, but only when you accurately predict Bitcoin’s price direction and learn how to manage the various risks associated with crypto investments.
Is Bitcoin futures trading safe?
The Bitcoin futures contracts trade is relatively, and the potential for loss of investment capital is great, especially when you involve leverage. But with quality research, proper risk management, and investment in the right type of futures contracts, the trade can be made relatively safe.
What happens when Bitcoins futures expire?
Bitcoin futures contracts are supposed to settle upon expiry. You are under obligation to buy or sell the predetermined amount of bitcoins agreed during the expiry date.
How long can a Bitcoin future position remain open?
A futures contract has a predetermined expiry date. This ranges from 1 week to beyond six months, though they typically have a lifetime of 3 months. American style bitcoin futures contracts nevertheless have the cash out clause that allows the trader to mitigate their losses by cancelling the contract at any time.
Will the Bitcoin futures contracts affect the Bitcoin prices?
Yes, Bitcoin futures contracts have an almost direct correlation with the price of actual Bitcoins. They are best used to describe how the crypto community feel about the price direction of the legacy digital currency, when the futures contracts are bullish, they will almost always inspire a spike in Bitcoin price and vice versa.