An Introduction To The Crypto Futures Markets

The introduction of Bitcoin futures in October 2017 has catalyzed the price swings in the world’s most distributed cryptocurrency. Opinions are divided as to the long term impact of a Bitcoin futures market. While Speculators drive the price up in anticipation of institutional money piling in, seasoned analysts anticipate that futures contracts will stabilize the price of Bitcoin through various risk management strategies. In this article we will try to shed some light on what futures contracts are, how they work and which platforms out there already support these trading instruments.

What are Futures contracts?

A futures contract is an agreement to buy or sell a tradeable asset at a specific date in the future. As with any contract, the agreed upon price and date must be honoured regardless of any change in market conditions. The goal of a futures contract is not always to profit maximise. Since the contract secures a price for both parties at a given time in the future, futures are often used as a risk management tool against dealing with any volatile asset class. Let’s take a look at an example;

FUTURES AS A RISK MANAGEMENT TOOL

Futures contracts are not new. Typically used by airlines to smooth fluctuations in fuel prices, the guarantee of a given price enables the airline to plan their annual costs and adjust the price of seats based on this. As an example, if fuel trades at $0.5 per litre, an airline that expects the price to rise in the coming months will “lock in” a future price of $0.5 with a fuel seller. If the prices then to rise to $1, the buyer has saved 100% of their costs. On the other end of the deal, futures contracts provide sellers with a guaranteed demand, enabling them to invest in the capital intensive equipment required to extract and refine the fuel.

When you hear terms like “long” and “short” used in reference to the futures markets, people are simply talking about which side of the deal each party is on. Those that take a long position are the buyers and those that short are the sellers.

FUTURES AS A SPECULATIVE TOOL

As with all markets, there are of course speculative traders that long and short futures. These traders are not looking to hedge their risk with guaranteed prices. Instead they try to anticipate the future price of the asset, benefiting by making the right call.

When the price of a commodity is low, speculators will lock in that price for the future in anticipation of the commodity rising in value. As the price rises, the contract increases in value and the speculator can sell the contract to another investor. To take the airline example, the speculator has bought fuel at $0.5 per litre and can then sell the contract close to $1 per litre as the market price reaches that target. It’s as simple as that. The speculator has taken on the risk that the price of the commodity will not rise and in this case it has paid off.

What are Bitcoin futures?

Bitcoin futures contracts simply mean that the contract will be based around the price of Bitcoin. Speculators that believe the price will rise will buy the contract at a lower price and those that expect the price will fall can sell their contracts to more optimistic investors. The contract price is based on the underlying value of Bitcoin on a given exchange.

Why would I buy Bitcoin futures instead of Bitcoin?

While Bitcoin remains unregulated, Bitcoin futures can be traded on exchanges that are regulated by local financial bodies. For those investors concerned about the risks that come with unregulated markets, futures contracts offer a reasonable investment option. In addition to this, countries that have banned the trading of Bitcoin may still allow trading Bitcoin futures giving a larger number of investors exposure to the emerging asset class.

As mentioned previously, futures instruments offer investors a risk management tool since they can hedge against the changing prices of the volatile crypto-asset markets.

Existing and upcoming Bitcoin futures trading platforms

There are currently around ten different markets that already enable trading of bitcoin futures with a number planned for the coming months. While there are many unregulated platforms, there are also a couple of well established exchanges that support Bitcoin futures:

  • Bitmex — High leverage with good liquidity. Allows futures, derivatives and margin trading
  • Etoro — CFD Broker that enables copy trading, supports futures and margin trading
  • Cryptocfacilities — Authorized and regulated by the financial conduct authority, they have recently introduced futures trading for Cardano.
  • Deribit — Gives access to futures, derivatives and margin trading
  • OKcoin — China based exchange with high liquidity and low fees. Supporting futures, derivatives and margin trading.
  • Bitflyer — Futures and margin trading available on this easy to use platform
  • CME (Chicago Mercantile Exchange) — One of the largest futures exchanges globally
  • CBOE (Chicago Board Options Exchange) — The largest US options exchange that launched Bitcoin futures trading in mid December

UPCOMING FUTURES TRADING PLATFORMS

Coinifloor — A UK based cryptocurrency exchange “targeting hedge funds, proprietary trading firms and sophisticated retail investors, as well as cryptocurrency miners.”

Summary

The news of CME and CBOE futures markets that was released in November last year sent the price of Bitcoin skyrocketing to all time highs. As the excitement of these new financial instruments subsided, institutional investors started to use the futures contracts to short Bitcoin, creating negative price pressure on this emerging asset class. With over ten futures markets available to investors, it is likely that the futures contracts will continue to act as a catalyst for price action in the markets. With high volumes of longs open during bull runs and shorting through bearish trends, the volatility of the market is set to continue through 2018 and beyond.