Crypto markets have a great and perhaps a crucial financial derivative product in crypto futures. A great tool to protect and hedge finances against the fluctuating prices of digital assets, the bitcoin futures contract is in fact one of the most popular crypto futures.
The financial world has undergone many changes and has witnessed numerous innovations over the years. With each change, access to money and how traders interact with its value evolved. At present, there are several financial tools that serve different purposes from derivatives to options and futures. Cryptocurrencies have breathed new life into financial innovations as they offer different financial instruments within their fairly new ecosystem.
As institutional investors also enter the crypto market, this $1.3 trillion industry is getting increasingly influenced by banks as well as professional traders. The equation between mainstream assets’ prices like bonds or stocks as well as crypto has furthered. Yet, till date, these pro-investors have only been able to trade bitcoin derivatives and not cash contracts which have propelled competition in the exchanges. Let’s try to understand what crypto futures are and how they work:
What Exactly Are Cryptocurrency Futures?
Basically, cryptocurrency futures are binding contracts that two crypto investors enter into to speculate on the digital currency’s future price. This includes the units, price, marginal requirements as well as settlement methods that are mutually decided by the investors.
Investors do not have to buy cryptocurrencies, in this case, to speculate on them. Just like the futures contracts for stocks and commodities, crypto futures are also a way to place your bets on an asset’s price movements.
How do they work?
Let’s assume that you’re an investor who buys two Bitcoin futures contracts that equal 10 bitcoin. At the time the futures contract was bought, one bitcoin was worth $5,000 which made the final sum for both futures contracts $50,000. Now say you had invested in a Chicago Mercantile Exchange (CME) Group Bitcoin futures contract where the margin requirement is 50% of the contract amount. This implies that you have to deposit $25,000 as a margin and perhaps get the balance financed through leverage.
The value of your contract will keep changing as the price of the asset, which is Bitcoin in this case changes. There’s a Bitcoin Reference Rate that CME uses which draws an average from Bitcoin prices across different crypto exchanges. This rate is calculated every day between 3 pm to 4 pm in CET (London Time). Whether you choose to hold on to the futures contract or sell it off would rely on Bitcoin’s price fluctuations. When the contract term ends, you can either roll over the contract to a new one or allow it to expire and get cash in return.
If you’re familiar with futures contracts in general, Bitcoin futures will not seem too difficult to grasp. Start by opening an account at a brokerage and wait for it to get approved. Once this is done, you have to get your trading service provider’s approval to actually begin futures trading. Usually, this depends almost entirely on the funding requirement functions and the investor’s derivatives trading experience.
This is also relevant for determining the leverage and the margin amounts that your trades would qualify for. Futures trading often uses leverage heavily to carry out trades. However, the maximum leverage amounts are generally government-regulated especially when it comes to regulated exchanges and trading platforms.
What potential do futures hold?
Tether’s shakeout remains fresh in the memory of many crypto traders. When this noted stablecoin that is valued in line with the U.S dollar, suddenly started breaking its peg to the currency, billions of dollars that were at stake were lost. It was one of the most shocking and one of the largest fluctuations the crypto markets had ever witnessed. Even Bitcoin and Ethereum which dominate the crypto market are registering losses.
In crypto futures, the price swings have been rather muted. Due to the dramatic market turbulence that happened recently, the number of arbitrage opportunities has also reduced.
These volatile episodes have boosted trading in crypto futures on the CME which has witnessed numerous remarkable peaks. This is also perhaps because professional traders are trying to limit their trading to secure, regulated market spaces.
For investors who seek to risk a limited part of their trades, derivatives like futures and options are lucrative. These tend to move within a predetermined timeframe and the investor is already aware of how much of their own money is at stake. The downside to this is that leverage opportunities are plenty and hence the probability of incurring losses is also high.
In all fairness, it would not be wise at this stage to assume that the crypto markets today are stable. Rather, they’re in the middle of one of their worst-ever meltdowns, even sparking fears that if this phase of low activity stretches, it may negatively impact revenues. Yet, more and more exchanges are competing with one another every day to earn their share in the crypto market. As start-ups become an example of exciting rags-to-riches stories, even traditional exchanges are trying to grow into the tempting crypto trading market.
But, there’s more to it…..
Gradually, crypto exchanges are spreading their wings into the U.S derivatives market which happens to be one of the most highly-regulated financial markets. A major reason for this is the growing demand for different financial products among retail investors. However, the top crypto exchanges are also eyeing traditional financial markets as several such exchanges have acquired a few small players in the traditional arena. This is a strong attempt to bring crypto futures and other derivatives into the conventional market space.
New crypto exchanges are also entering the market and according to the data website coin market cap, this number now stands at 526. These are gaining momentum by driving the attention of professional investors. This has been a major reason for Bullish’s success–a platform that is trusted by hedge fund owners who happen to be billionaires!