What are Bitcoin Futures?
The bitcoin industry itself is in its nascent stages but drawing considerable attention globally. Just when cryptocurrency itself is breaking out of a relatively smaller user base, as compared to other conventional financial products, there is more coming up. Welcome to Bitcoin Futures!
An Introduction to Futures and Bitcoin Futures
The concept of futures is now a well established and traded segment with its presence across stocks, commodities and the forex markets. Fundamentally, futures are contracts that confirm the purchase or sale of an asset at an agreed price on a future date. Both the buyer and the seller have an obligation to comply with the agreed contract before its expiry date.
Bitcoin futures are no different from futures on other financial assets. It is a contract that involves cryptocurrency with a predetermined price. The intent is to make a wager on the price of a specific bitcoin for a specific timeframe. Here, neither the buyer nor the seller has physical ownership of the bitcoins being traded in.
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The Bitcoin Futures Operating Framework
Bitcoin futures have been around since 2017. It is also now widely available with more and more exchanges. From its early days when trading in it was difficult for the average investor, it is now getting more transparent and regulated.
As mentioned above, the principle of conventional futures applies to the cryptocurrency world too. So, anyone foreseeing the prices to go up will take a long position while those looking to offload bitcoins they digitally possess go short.
Out of the exchanges that deal in bitcoin futures trading, the CME and the CBOE, based in Chicago, are among the largest and most prominent. Established in December, 2017, these two exchanges have played a seminal role in opening up the bitcoin trading market to institutional investors.
Besides these, there are other major exchanges that deal in bitcoin futures. These include:
- BitMEX is one of the largest cryptocurrency exchanges and trading platform operating around the world that offers Bitcoin futures trading (not available to US citizens).
- TD Ameritrade is one of the largest brokerage firms in the world that offers Bitcoin futures trading.
- OKEx is a Malta-based world-leading cryptocurrency trading platform offering Bitcoin futures (not available to US citizens).
- Nasdaq is the second largest stock market exchange (by market cap) in the world.
- Bakkt is a Bitcoin futures trading and custody platform backed by the Intercontinental Exchange (ICE) which owns the NYSE. The open platform is available for all cryptocurrency services, including trading and warehousing. It features Bitcoin to fiat conversions.
The exchanges bring a level of credibility with their role in guaranteeing that the concerned parties of a futures contract comply with their obligations. This has increased confidence in investors who were earlier staying away from the cryptocurrency market, wary of the lack of regulations governing it.
How Bitcoin Futures Work
To begin trading in bitcoin futures, it is useful to know the basics and the process well.
Firstly, being futures, there are no physical bitcoins involved in the trade nor is there any requirement for the investor to possess a wallet or to join a cryptocurrency platform. The settlement happens on the date of delivery or by the trader closing out their position before that. The difference between the buy price and the price on the delivery date will be used to square the position. Depending on whether there was a gain or a loss, the payout or the settlement is done to close out the contract.
Each futures contract comes with an expiration date by which traders have to complete trading. During the period the contract is open, they can either close their positions or complete the settlement.
The settlement date for a contract is the date on which all legal obligations have to be fulfilled. The contract gets settled by paying out the contract holder the consideration of the underlying asset at the market price prevalent on the settlement date.
So, as an investor, here is a sum-up of what you should know about bitcoin futures and its working.
- Bitcoin can be inherently risky and volatile and is prone to extreme swings in its prices.
- Bitcoin futures can be a good option to reduce the risks arising from such volatility.
- Leverage can be helpful to open up bigger opportunities but there is the added risk with that.
- Choose your exchange carefully. It is strongly advised to stick to established and reputed ones.
- Begin with small allocations per trade. Do not pump in your whole capital in one position but spread it across multiple to avoid huge losses.
- Cross margin trading can be a useful strategy as the whole deposit can be utilised as collateral and gives you the flexibility to move balances. This helps safeguard your positions even in highly volatile situations.
- Watch your support and resistance levels. Just like in the trading of any other asset class, look out for levels below which the price will not fall further and a support is encountered. Similarly, monitor for levels above which there is a resistance found.
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Pros of Bitcoin Futures
Bitcoin futures are still evolving and there are operational and regulatory points to be addressed even now. But there has been some ground covered and the confidence in the cryptocurrency market on bitcoin futures is growing.
Here is what we think are some clear benefits emerging for it.
Availability on regulated exchanges
Investors who may be wary of dealing with bitcoins at a cryptocurrency exchange can seek the reassurance of trading in bitcoin futures at regulated exchanges. This has been instrumental in opening up the doors for regular retail players and institutional investors.
Bigger reach with institutional investors entering
When institutional investors enter the market, they bring individual and retail investors into the fold with them. This opens up the overall market and this can lead to more new entrants and funds coming in.
Comfort level of virtual bitcoins
Again, for newcomers to the cryptocurrency world, bitcoin futures help a more comfortable entry and trading. This is because it is possible to speculate on the price without having to worry about storing bitcoins themselves.
Reduced volatility in the market
The introduction of futures to a market like cryptocurrency helps bring about more stability as the volatility that accompanies bitcoin trading can be reduced.
Opportunities for leveraging and hedging
Trading in bitcoin futures offers the advantage of access to leverage which can both open up opportunities and lessen the risk of having to store cryptocurrency. Similarly, futures also allow you to hedge by taking a short position in a bear run.
Advent of regulation
One of the challenges faced by cryptocurrency is the difficulty in its mass acceptance, given the complexity of the concept and the lack of enough regulation when it began.
Risks of Bitcoin Futures
Since its advent, cryptocurrency has come some way from being a very niche and self-contained ecosystem to becoming an evolving platform with a wider user base.
But, when compared to the traditional asset classes like stocks, commodities and forex, it is still not easy to break into the bitcoin world for the average investor.
On one hand, there is the lack of widespread access to information and understanding on the products and processes.
Also, the unconventional nature of the asset does not easily inspire confidence even in the experienced traders and investors active in the conventional markets.
Similarly, the requirement of capital needed to trade in bitcoin futures comes with its own challenges.
A higher degree of risk involved
Futures carry an inherent risk due to the unpredictable nature of the outcomes of the bets placed on any asset. With a nascent asset like cryptocurrency and its characteristic volatility, the possibility of a call going wrong can push a trader into incalculable losses.
Bitcoin futures offer leveraging as a tool to maximise profits but, if not used cautiously or during a particularly difficult market condition, this can only compound the risk.
Possible manipulation in prices
Manipulation of prices can happen in any market but in a relatively newer and unregulated market like cryptocurrency, it becomes all too real. Investors with deeper pockets can exploit bitcoin futures to their own benefit.
An example is their ability to make substantial sell orders to fake a bear market that can prompt a mass and panic sell out. In time, these larger investors can again buy back the sold portions at much lower prices to make huge profits.
Difficult to manage volatility
Cryptocurrency is all about volatility and uncertainty and bitcoins futures are not too different. For all the additional regulation and the smoothening of the processes, it is still a game newcomers should play carefully.
There are operating fees associated with bitcoin futures. Prepare for this and compare what is charged by various exchanges.
Coping with short squeeze scenarios
Watch out for squeezes that are a reality in the crypto and bitcoin world. Any unforeseen and unexpected squeeze can severely dent your position and can cause heavy losses.
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Virtual currencies are highly volatile. Your capital is at risk.