12 March, 2020 | AtoZ Markets – The introduction of Bitcoin futures on a regulated trading platform has brought the digital currency closer to mainstream investing. Some financial skeptics still believe that crypto assets are risky and speculative for investment purposes. On the other hand, many crypto enthusiasts also believe that futures trading may bring institutional money to the crypto industry.
Let's have a closer look at what you should know about Bitcoin Futures.
What is Bitcoin Futures?
Bitcoin futures are contracts that speculate on the Bitcoin price without actually owning it. Futures trading platforms offer physical delivery of the underlying asset for contracts. However, it remains within their custody rather than available to purchasing parties to buy and sell Bitcoin on cryptocurrency exchanges.
Traders who participate in Bitcoin futures usually make a bet on the price of Bitcoin over a specified period. Bitcoin futures work like any futures contract on a traditional financial market. Investors can go for long and short on Bitcoin with an expectation that the price will fluctuate. They mitigate potential losses if they own some Bitcoin.
For example, if Mr. X owns 2 Bitcoin at $10,000 and expects the price to drop, she can sell a futures contract at the current price of $10,000. If the price drops to $5,000 near the expiration of the contract, she can buy the futures, meaning that she protected $10,000 on her investment by selling at a higher price than and then buying at $5,000.
Advantages of Bitcoin Futures
Bitcoin futures have several benefits for investors
- Bitcoin futures traded on regulated exchanges. Therefore, the process is much more familiar and comfortable for retail and institutional investors who don't want to deal directly with cryptocurrency exchanges.
- The contract allows for speculation on the underlying price of the asset without going through the process of storing bitcoins. It is a high barrier to entry for many people who are unfamiliar with Bitcoins’ activity.
- It grants Bitcoin more exposure to investors with more liquidity to the market. The futures trading can lead to less volatility of Bitcoin’s price on a long-term basis. Therefore, it enables investors to protect themselves from unexpected price swings.
Institutions also offer Bitcoin futures trading to their clients as it is within a regulated exchange. Therefore, it reduces the risks associated with holding bitcoins.
What Should You Know About Bitcoin Futures Trading?
Bitcoin futures brought the institutional money in the crypto industry that may make the cryptocurrency stable in the long run. There are some other things you should know about Bitcoin futures.
#1 Bitcoin Futures Has a Strong Regulation
Regulation on Bitcoin futures is one of the most doubted and controversial advantages of Bitcoin futures contracts. Many hardcore crypto fans believe that the regulatory environment disables the decentralized nature of cryptocurrency. However, the majority of market players confirm that the regulation is essential for the mass adoption of Bitcoin. Commodity Futures Trading Commission (CFTC) regulates the Bitcoin futures markets, which is not as strict as SEC. It sets the rules for participants, and it ensures equal opportunities for investors and speculators, fraud protection, and predictability.
#2 You Can Hedge Bitcoin Futures with Spot Markets
Traders and Speculators use Bitcoin futures to bet on future price movements to hedge spot market positions. Moreover, investors can use it to get benefit from both buying and selling market trends without actually having the underlying asset.
For example, suppose you expect the price of Bitcoin to move up. Therefore, to buy a futures contract, you have to provide 50% from the contractual value as a marginal collateral and exchange fee from $15 to $30 depending on the trading platform.
If the Bitcoin moves higher than your price agreement, you will make a profit from the surplus. However, if the price goes down, you'll incur substantial losses as you need to pay the difference and maintain the collateral at the required level.
#3 Bitcoin Futures has High Entry Barriers
Large trading platforms, like CME and CBOE, have high market entry barriers. It is affordable for wealthy individuals or institutional investors only.
Moreover, CME allows having two-month future contracts for 5 BTC. The minimum price fluctuation for this is $5 per Bitcoin or $25 per contract. Furthermore, the maintenance margin is 50%.
The futures price is set on the Bitcoin Reference Rate (BRR). It is an aggregated rate among major bitcoin spot exchanges between 3:00 p.m. and 4:00 p.m. London time. As they settled on a financial basis, no real Bitcoins are involved. It means that traders can make a profit from Bitcoin's price movements without owning it. CBOE allows having Bitcoin futures for 1 BTC with a similar trading condition.
#4 Price of Bitcoin Futures is Transparent
Bitcoin futures contracts are settled every day, based on transparent reference price. It reflects all Bitcoin-related contracts. Unified price reference reduces the volatility of spot prices and makes Bitcoin suitable for making payment.
#5 Investors Can Trade with Leverage
Leverage allows Bitcoin futures trading, like paying only a portion of the original price. It makes futures trading more attractive to investors as they get an extra loan from the broker.
On the other hand, it makes trading hard and may cause losses if a trader misuses it.
#6 There is a Risk of Price Manipulation
Large investors with significant investments can use futures for price manipulations. Thus, they can place large sell orders with futures and create bearish sentiments. Therefore, force smaller investors to get out of their assets while it is not too late. When the price goes much lower, it allows large players to buy at a discounted price.
#7 High Investor Requirements
Bitcoin futures should make crypto trading easier and attractive to new investors to the market. However, they are not readily available to everyone. CBOE and CME require 50% of the value as marginal security, which is pretty high.
On the other hand, it requires a 10% margin for traditional assets. The extreme volatility requires a high margin requirement, but they raise the entry barrier for retail investors. Apart from that, both CBOE and CME offer Bitcoin futures trading for qualified investors only. That means retail investors will not be able to trade bitcoins legally unless they are eligible themselves.
Moreover, BAKKT bitcoin's future trading is available on most of the exchanges.
#8 There are Risks of Losses
Bitcoin futures are highly risky instruments and have a risk of potential losses. If you are wrong with your price forecast, your money may get out of your pocket to the trader who got it right. Moreover, leveraged trading and the volatility of cryptocurrency markets may make the loss substantial.
Both CBOE and CME try to minimize risks with their so-called price limits of 7%, 13%, and 20%. They apply it both to upside and downside movements compared to the previous day’s Bitcoin futures settlement price. Therefore, it will not allow you to change more than 20% daily.
Summary
As of the above discussion, we can come into conclusion with these-
- Bitcoin futures are derivative instruments that are introduced by CBOE and CME upon approval obtained from CFTC.
- Bitcoin futures are an agreement to buy or sell bitcoins at a fixed price on a specific day. Moreover, exchanges also offer two-months financially settled contracts.
- Investors can buy or sell Bitcoin futures with leverage, which affects potential profit and loss. Moreover, it may work as an advantage or ruin their financial position.
- Bitcoin futures have many advantages than spot crypto markets. Some of them are the higher price transparency, heightened security, and short selling option.
- The main drawbacks of the Bitcoin future are high investor risks, potential price manipulations, and high investor requirements.
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