Futures trading is common practice in the cryptocurrency space, with CME and CBOE futures exchanges for Bitcoin futures, and among the crypto-based is BitMEX among the most notable exchanges.
What Are Bitcoin & Crypto Futures?
Crypto futures are a way to trade the future price action for crypto assets. Bitcoin futures are the most common crypto futures, hitting the mainstream financial world around this time last year.
The Chicago Mercantile Exchange (CME) and the Chicago Board Options Exchange (CBOE) listed cash-settled Bitcoin futures trading products in December last year. Cash-settled means these futures are not backed by actual Bitcoin. When the futures contracts expire, the value is paid out to the trader in cash instead of Bitcoin.
Online broker Trade Station explained futures contracts in a simple fashion. They are “an agreement to make or take a delivery of a commodity or financial instrument at a fixed date in, you guessed it, the future.”
Each futures contract contains a specified amount of the traded product. In the example of CBOE Bitcoin futures, each futures contract contains one Bitcoin and is settled based on the Gemini crypto exchange auction price for Bitcoin.
These futures contracts (in this case, Bitcoin) can be bought or sold at will by the trader at any point within the contract time frame, as market supply and demand dictate the price of the contract and the underlying asset (Bitcoin).
So as a trader or market price speculator, futures allow you “to take futures positions, along with their risk and opportunities, without ever having to take delivery of the underlying asset,” as explained by Trade Station.
How Does Futures Trading Work?
On the CME or CBOE, traders can earn or lose money speculating on the price of Bitcoin, without actually buying or holding the underlying asset.
Buying Bitcoin Futures (also called “going long” or “longing”)
A significant portion of futures trading involves trading these contracts multiple times between contract open and contract expiration. Trading Bitcoin futures often involves constantly adapting to changing market sentiment, buying and selling contracts based on Bitcoin’s spot price accordingly.
For example, say a trader named Dave decided to trade those Bitcoin monthly futures several times during a November 1st – December 1st contract period (fictional for this example). Dave could essentially buy into a Bitcoin futures contract position at any point in this time period at market price (Bitcoin’s price at the time of purchase) and then sell at any point before the December 1st expiration, seeing either profit or loss based on Bitcoin’s spot price. Dave would be paid out in cash depending on the profit or loss outcome.
A specific example of a trade Dave could take, could see him buying a Bitcoin futures contract at $3,100 on November 8th, and then selling on November 10th for $3,200 (if Bitcoin’s spot price rose that much in that time period), seeing a $100 profit, paid out in cash. Although if the price instead went from $3,100 to $2,900, and Dave sold the contract at $2,900, he would only receive a payment of $2,900 back, seeing a loss of $200.
Selling Bitcoin Futures (also called “going short” or “shorting”)
Dave also has the option to short-sell Bitcoin futures. This basically means betting that Bitcoin will fall in price in the future. When Dave short-sells a Bitcoin futures contract, it means that he borrows one Bitcoin futures contract from someone else on the exchange and sells it, hoping to buy the contract back at a lower price and keep the price difference. This is done by the exchange, so traders do not have to individually seek out contracts to borrow and then give back later.
For example, if Bitcoin’s spot price is at $3,000 on November 3rd and Dave thinks it will fall to $2,000 by November 18th, then he would sell a Bitcoin futures short contract utilizing CME or CBOE exchange features. If Dave sold one Bitcoin futures contract short at $3,000 on November 3rd, and the price fell to $2,000 on November 18th, he would buy the contract back and receive a cash payout of $4,000 (his initial $3,000 plus a $1,000 profit).
In the same short trade example, once Dave entered his short position at $3,000, he would be able to close that position at any point, up until the December 1st expiration. So if Dave sold one short contract at $3,000 on November 3rd, and Bitcoin’s spot price dropped to $1,500 on November 8th, Dave could buy that contract position back at his discretion, thus ending the trade and taking home a profit of $1,500. On the other hand, if Bitcoin’s spot price rose to $4,500, and Dave chose to end the trade, he would terminate the contract and take a loss of $1,500.
What is Contract Expiration and Settlement?
Contract Expiration is the date at which futures contracts expire and end trading activity. “Prior to the expiration date, traders have a number of options to either close out or extend their open positions without holding the trade to expiration, but some traders will choose to hold the contract and go to settlement,” explained CME Group on their website.
Contract settlement also occurs on a specified date. CME Group explained settlement as “the fulfillment of the legal delivery obligations associated with the original contract.” Therefore, on the specified date, the amount of the underlying asset would be given to the holder of the contract, at the market price at the time of settlement.
Since CME and CBOE Bitcoin futures are cash-settled, the contract holder would receive the fiat (USD, etc.) value of the contract’s price at the time of settlement. For further info: CME Bitcoin futures settlement dates.
Do future settlements have an effect on Bitcoin’s price?
Futures of the global stock exchanges, such as NASDAQ, do have effects on the markets. Hence, it’s widespread to think that CME and CBOE Bitcoin futures carry the same impact on Bitcoin’s price.
This is sometimes true. Looking at the Bitcoin’s chart, compared with the futures settlement dates, often there was a price action which is likely to be ahead of the settlement event, but as you will see, not always there’s such action.
We can also see Bitcoin’s price action during the most recent futures settlement on December 28, 2018:
Unlike June and December settlement, the futures settled in September 2018 had shown minor Bitcoin fluctuations.
To summarize the effects, despite that this could also be only a coincidence, we can assume in a high-probability that the CME and CBOE future settlements do affect the Bitcoin’s price.
BitMEX Bitcoin & Altcoins Future Contracts
Unlike CBOE and CME, BitMEX futures are crypto settled, meaning the underlying crypto asset is delivered upon contract settlement.
BitMEX recently announced the addition of several new crypto futures contract listings, paired with Bitcoin. “On 17th December 2018, the March 2019 quarterly ADA (Cardano), BCH (Bitcoin Cash), EOS (EOS), ETH (Ethereum), LTC (Litecoin), TRX (Tron), and XRP (Ripple) futures contracts will be listed,” BitMEX stated in a recent blog post.
Since these contracts are paired with Bitcoin, their value is evaluated in terms of their Bitcoin value. Contract sizes for these new contracts are one coin of the specified asset (1 ADA, 1 EOS, etc.). For example, one EOS token would roughly equate to 0.000685 BTC (value at press time). The mentioned futures contracts speculate on the Bitcoin value these new assets will hold at the time of quarterly expiration.
BitMEX Bitcoin Perpetual Futures
BitMEX is famous for these perpetual contracts. Each contract equals $1 USD, with no settlement or expiration date. With these perpetual swap contracts, traders can trade in and out of positions as many times as they see fit, without having to take note of expiration dates as is the case with the CME and CBOE. BitMEX allows its traders to leverage up to 1:100. For more info, visit CryptoPotato’s BitMEX guide for beginners and advanced guide.
However, these perpetual futures contracts do have something called funding, which occurs every eight hours and can impact profit or loss. “You will only pay or receive funding if you hold a position at one of these times. If you close your position prior to the funding exchange then you will not pay or receive funding,” BitMEX explained on their site.
Put simply; funding is comprised of an interest rate and a premium or discount. “This rate aims to keep the traded price of the perpetual contract in line with the underlying reference price. In this way, the contract mimics how margin-trading markets work as buyers and sellers of the contract exchange interest payments periodically.”
Bitcoin & Crypto Trading Futures: Pros and Cons
– The option to bet against the market: Futures are both ways. Hence, you can short against your favorite cryptocurrencies.
– Leveraged Trading: Futures allow you to leverage your capital. This can also be another advantage for crypto-based exchanges because there is always a risk in holding crypto on exchanges (for security reasons).
– Hedging: From the above reasons, trading futures is an excellent method for hedging any portfolio. Instead of selling your BTC, you can buy some short futures to hedge your portfolio during a bear market such as the one we had in 2018.
– High Risk: Futures are considered the highest risk trading instruments. Pay attention to the liquidation price that the amount of collateral allows you.
– Squeezes can kill: Sudden unexpected short or long squeezes can turn a profitable position into a bloody loss at once. In crypto squeezes and manipulations are part of the game.
– High volatility: On one hand volatility is Heaven for traders; on the other hand, volatility sometimes makes it hard to determine the market sentiment.
– Fees: Borrowing money is never free, sometimes the fees are costly. Fees differ by exchange.
Cryptocurrency charts by TradingView. Technical analysis tools by Coinigy.