The futures of Bitcoin

Bitcoin trading is rapidly growing up. Beyond the basic buying and selling of BTC on the spot or cash market, you now have access to derivatives in the form of futures.

Futures are relatively new to the crypto space with the first official Bitcoin futures contract initiated by the CME Group in 2017. Since the establishment of this first regulated futures contract, other crypto futures products have been developed at numerous exchanges across the world.

One notable entrant was Jeff Sprecher’s NYSE/ICE group with Bakkt. Sprecher has built an equities and futures exchange and clearing empire across the globe, starting with a dollar and a startup twenty years ago. Bakkt represents his groups’ confidence in the staying power of both Bitcoin specifically and the cryptocurrency asset class more broadly.

BTC futures are a growing business

Independent crypto exchanges have developed a variety of new crypto futures offerings in various locations around the world. As with many aspects of the maturing cryptosphere, these products have borrowed heavily from experience in the legacy financial markets. Even amongst unregulated exchanges and products, several best practices have implemented as a measure of self-preservation.

According to the 2019 Coinshares Crypto Trends Report, combined futures volumes for the top 13 exchanges come in around the 3.3 billion contracts per day range, as of 2019. Volumes in these Bitcoin derivative products were lacklustre at first, but like Bitcoin, they have continued to grow.

Futures exchanges are adding additional elements to their offerings, including options on BTC futures for Bakkt, CME Group and others, as well as insurance protection and, in some cases, custody services.

Futures have some advantages

Futures markets provide crypto traders with some important advantages and disadvantages.

On the advantage side, you gain access to leverage and perhaps a lot more leverage than is typically available on cash exchanges. Traders also gain access to another way to express an opinion about the direction of Bitcoin’s price and, in some instances, other crypto assets.

Crypto futures also provide BTC traders and hodlers with a way to hedge portfolios of crypto assets. And with established, regulated futures exchanges playing a prominent role in the space, they give room for large regulated institutions to experiment and be involved in Bitcoin, even if only on a cash basis.

For larger position traders, institutions and hedge funds, crypto futures can represent an essential asset management tool. This includes using futures to exploit international BTC price discrepancies on a variety of exchanges through arbitrage opportunities.

…and some disadvantages

But crypto futures have some disadvantages as well. The amounts of leverage involved may be unsuitable for many smaller inexperienced traders who may be unprepared for the potential losses.

With margin trading now available on various exchanges, futures may not be the most efficient way for these individuals to participate in Bitcoin.

And using futures products and crypto exchanges outside of your jurisdiction may come with some added challenges, including the ability to access your cash easily and on-demand.

A long contractual history

Futures have historically been used by producers of agricultural products and exploration and extraction industries like mining and energy. Futures markets provide a way for producers to hedge their price exposure on products they mine or produce.

The industry has gone on to include financial products like indices, bonds and other debt instruments as well as currencies.

Futures are based on contracts between a buyer and seller, with a central clearing entity acting as the counterparty to both parties.

Hedgers and speculators

Trading in futures typically involves a hedger and a speculator.

The hedger may sell a contract to lock in prices at a future delivery date for a product they produce. Another hedger might buy a contract to lock in the price of a product supply they need for future business operations.

Speculators supply liquidity to hedgers by buying the contracts they sell or selling the contracts they want to buy. They may also buy or sell futures to manage a portfolio of holdings or make a directional bet on some future event.

An example of a speculative futures trade was when Andrew Hall bought oil during the price collapse in 2008, stored it on tankers and sold futures. His profit was the difference between the futures price and the spot price minus the tanker storage and delivery fees. He reportedly earned a $100 million bonus for that trade.

The Commitments of Traders Report from the CFTC shows you how hedgers and speculators are involved in a given commodity at any given time. Position limits are standard, well defined and rigorously enforced to prevent market manipulation like cornering.

Contracts come with specifications

Each futures contract has a clearly articulated set of specifications. Different exchanges may have different contract specifications. For example, Bakkt and the CME both have Bitcoin futures contracts, but the specs for those contracts are different.

In the legacy market, there are strict rules regarding futures trading, including position limits, daily trading price move limits and clearing. All of these rules are designed to prevent abuses of various markets that are key to the global economy and businesses at large.

Where Bitcoin relies on mining, futures clearing is managed by a central authority. This central authority acts as the counterparty for the buyer and seller to insulate both parties from any failure of the other.

Look at the fine print

Traders interested in trading BTC futures should take the time to understand the contract specifications they are considering trading.

First, you should look at the margin deposit requirements. Does the exchange require BTC or cash, and do they have adequate insurance to cover losses?

What are the trading times? Not all exchanges are 24/7, like Bitcoin.

What is the contract size? Is one lot 1 BTC or 5? Or is it based on a cash amount?

How and when does the contract settle? Is it settled in cash or BTC?

When is settlement, and what are the requirements for settlement? And what is the spot market they are using for settlement prices?

And it would also be a good idea to figure out how easily your money can be moved in and out of the exchange. Not every crypto exchange makes this easy for foreign clients.

The future of Bitcoin is tethered to futures

Futures are a logical extension of the current trend in crypto. This trend includes the extension of leverage, the development of unique contracts, and the increasing use of margin in trading products.

The ongoing expansion of the futures market provides arbitrage opportunities for large entities and the ability of regulated financial institutions to test the cryptocurrency waters.

All of which help to develop a more efficient and well-organized market ecosystem for both BTC and the cryptocurrency market of the future.

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Originally published at https://bitvo.com on January 16, 2020.