Futures contracts have been popular since the 20th century in the United States. Some may think that the notion of futures is quite outdated, but with Bitcoin’s emergence, it has seen a strong revival.

Introduction

• A futures contract is an agreement between two parties, one of them taking an obligation to sell, the other to buy a specific quantity of an asset at a previously agreed-upon price at a definite date in the future.

• Bitcoin futures contracts make the market more liquid and gives traders additional opportunities to derive income from the difference in buying and selling prices.
• The price of Bitcoin is volatile, therefore, the value of Bitcoin futures changes accordingly to the bounces in BTC’s price.

Bitcoin is the leading crypto asset with the biggest market capitalization. Just like with all cryptocurrencies, the price of Bitcoin is subject to extreme volatility. For instance, in the beginning of Spring 2020, which marked the start of a pandemic across the globe, Bitcoin basically lost half its price responding to markets’ confusing behavior triggered by fears of crisis. By the early days of Autumn 2020, Bitcoin had managed to recover the price that grew by 3 times from March’s 4,000 USD. Then the price lost positions again and fell below 10,000 USD.

Traders who practice spot trading – an on-the-spot purchase or sale of a cryptocurrency with instant delivery – usually exchange currencies according to their current value, and there’s a risk of losing money because the price may fall or rise any second. No one even thought about fixing a price for a currency while it’s low and actually purchasing it at the low price later, when the current price is a few times higher. Today, futures contracts make it possible.

A futures contract is an agreement between two parties for a particular amount of an asset to be sold and purchased at a particular price on a particular day. Thus, traders could have concluded a futures contract in April, one to sell and the other to purchase, say, two Bitcoins for 8,000 USD on September 1st. Once the agreement is reached, the deal must be made, despite the fact that the price of Bitcoin in September is already 12,000 USD. Therefore, if a similar contract was truly made by anyone, the buyer made significant profits while the seller had to face extreme losses.

Once the crypto community fully realized the potential of Bitcoin futures contracts, they became a new trend with astonishing popularity, especially once large financial markets like CME Group arrived on the stage. Bitcoin futures contracts first came into the market in December 2017 on CBOE exchange. Soon another exchange – Chicago Merchant Exchange – joined the move and introduced futures contracts to its users. Today thousands of futures contracts are made daily, and the numbers are due to increase at least because trading futures contracts in Bitcoin enables traders from crypto-banning countries engage with trading crypto on a legal basis as trading a crypto futures contract doesn’t mean trading crypto in legal terms.

The industry’s largest exchanges, such as Binance or OKEx, report billions of dollars’ worth of futures contracts traded on a daily basis with average daily volumes growing quarter by quarter.

Futures Contracts as a Part of Asset Class Expansion

The emergence of Bitcoin futures contracts is a major step toward the development of new ways to trade asset classes. Bitcoin has evolved into a blossoming asset class that provides investors with much valued properties, such as liquidity and opportunities of arbitrage income.

An Interesting Fact

The first futures agreements emerged in the 17th century in Japan. Local samurai received remuneration for their work in rice and were preoccupied that the value of the rice may get reduced in the future. Thus, samurai requested to conclude special agreements to pay the equivalent volume of rice in the future which value will remain equal to its value as of the date of agreement conclusion. That was the first futures contract.

The advantage of trading Bitcoin futures contracts compared to spot trading is that a futures contract doesn’t require traders to hold the coin, just like Japanese futures founders didn’t have to store tons of rice. Traders speculate on the future price of the asset, and futures contracts are regulated by the Commodity Futures Trading Commission, providing investors with a fair share of confidence.

Cryptocurrency exchanges are welcoming futures contracts by requiring less fees for trading them then trading cryptocurrencies, which gives traders more opportunities to earn.

How to Deal with Futures

Trading Bitcoin futures is sometimes more beneficial than trading Bitcoin itself. Futures enrich the market with liquidity, and traders can earn on selling at a profit. Apart from that, trading Bitcoin futures doesn’t involve actual exchange of Bitcoin as futures traders don’t need to have a wallet. Traders don’t need to store futures or Bitcoin, yet they are traded on an exchange like any other currency. The value of Bitcoin futures reflects the price of Bitcoin, rising and falling accordingly.

Entering a futures contract, traders can choose from a few ways to exit positions. The first one is simply closing out the position by creating another contract of equal value and neutralizing their obligations. This approach is called offsetting a contract, and it is the most popular one. The second way is by rolling the contract over, which means moving the position from front month to another contract in the future with a definite expiry date. In other words, traders extend the position expiration by closing one contract and opening another one with a long term of validity. One more way to exit a position is called expiry, which is simply executing the obligations envisaged by the contract once it reaches its expiry.

Futures and Hedge Funds

Traders can use futures contracts as part of their hedging strategy. Hedging is a risk-management strategy used to minimize financial risks when making an investment. It is especially widespread in the crypto industry as traders need instruments to deal with cryptocurrencies volatility.

How does hedging work within crypto space? Let’s imagine a trader who decided to purchase two Bitcoins at 12,000 USD each. The trader believes that the price will increase in a month, but would like to minimize the risks in case the price falls. To do that, the trader can enter a futures agreement to sell one Bitcoin at 12,000 USD in a month. Finally, when a month passes by and if the price rises, the trader will earn from selling one Bitcoin at a current increased price. If the price falls, the trader will face losses, but they will be two times less than if the trader didn’t enter a futures agreement, because the trader will be able to sell one Bitcoin for 12,000 USD.

Hedging strategies deal with risks and are designed to minimize them, but it’s important to understand that the potential yields get limited accordingly.

Futures: The Essentials

Bitcoin futures contracts aren’t always a magic wand. Entering a futures agreement is a risky venture that means financial duties that must be performed once the contract reaches its expiration date.

Futures contracts can help earn good money, but they can also oblige traders to sell at a price far below market or buy at a few times higher price then currently offered. Cryptocurrencies are extremely volatile, and Bitcoin is the most volatile one. Trading futures successfully requires having a solid knowledge of the market and a bit of luck, of course.