Bitcoin futures trading came into existence in the United States in late 2017. These Futures provided traders to estimate Bitcoin market price without having to own Bitcoins. This trading was considered as a milestone bridging the gap between digital investment and traditional investment.
What are Bitcoin Futures?
An agreement to sell or trade an asset, Bitcoins in this case, at a specified future date and at a specified cost is known as Futures (Bitcoin Futures). Once the price of a future has been set, both parties have to trade at the same price irrespective of the market price.
Why Futures are Traded?
You might be wondering when assets are traded normally, what is the need for the Futures concept?
Bitcoins and other assets are volatile i.e. price of such assets are not constant. Companies and businesses buy futures to fix the price for a specific time period, which gives them the luxury of price stability even in volatile markets, while investors often use futures for hedging risks or speculations as the value of the futures contracts is based on the overall performance of an underlying asset.
How Futures Value is Calculated?
The theoretical formula for calculating the futures price from the spot price is as follows:
Futures Price = Spot price *(1+ rf – d)
Where, rf = risk-free rate on an annual basis, and d = dividend
The above formula needs to be customized for two points that are particular to bitcoin – (1) the change for risk-free rate from an annual to a daily basis, and (2) there is no dividend in cases of bitcoin, ‘d’ can be removed.
Bitcoin Futures Price = Bitcoin Spot price * [1+ rf*(x/365) ]
Where x = number of days to expiry.
How Bitcoin Futures trading work?
Bitcoin Futures Trading works in a similar fashion to how traditional future trading works.
Using the above formula, a certain Bitcoin value is decided between the trading parties and traded accordingly.
There are 2 types of Futures –
- Long position Future – If you are planning to buy a Bitcoin, you can opt for Long position Future which states that you agree to buy the Bitcoin in the future at a specified price when the contract expires
- Short position Future – If you are planning to sell Bitcoins, opt for short position Future which states that you agree to sell the Bitcoins at a set price upon the contract’s expiration.
Where are Bitcoin Futures traded?
Bitcoin is a cryptocurrency, there are a few different platforms to trade.
- Cryptocurrency trading platforms – One can buy cryptocurrency futures by trading bitcoin against cryptocurrencies or fiat currencies.
- Foreign currency exchange (forex) – One can buy bitcoin futures by trading bitcoin as part of a currency pair.
- Options exchanges. – One can buy bitcoin futures by estimating the future price of BTC in US dollars.
Bitcoin Futures Benefits
Despite some controversy, these are the reasons why Cryptocurrency market is still blooming
Transparent reference prices are reflected in all Bitcoin-related contracts. Based on these, Bitcoin futures contracts are settled every trading day. Common price reference reduces the volatility of spot prices, making Bitcoin suitable for payment purposes.
Crypto fans believe that the regulatory environment kills the non-authority nature of cryptocurrency that was born to be free, but the majority of market players are sure that regulation is a necessary step to Bitcoin mass adoption. The Commodity Futures Trading Commission (CFTC) supervise the futures markets. It also sets the rules to be observed by all participants, ensuring equal opportunities for investors and speculators, fraud protection and predictability.
Institutional money and enhanced liquidity
Investment organizations will not touch anything that is not regulated, while futures offer them an easy way to get involved in operations with digital assets. It means that in the long run, these regulated instruments will attract professional players on the market
Bitcoin futures provide traders to bet on price fall without actually owning the asset. It increases investment opportunities for crypto players, namely for those who don’t have Bitcoins, but believe that the price will go down.
Bitcoin Futures Risks
However, there are a couple of risk factors to be considered by potential investors.
- Risks of losses
Bitcoin futures are considered to be highly risky instruments due to potentially significant losses. If you are wrong in calculating the estimated Future value, you will lose the money to the trader who got it right. Depending on the volatile nature of cryptocurrency markets, the losses may vary.
Some traders from futures markets have said that they’re seeing a lot more business on the “long” side of the market than the “short,” suggesting that more people estimate bitcoin prices to increase and have been holding bitcoin on forex and options exchanges.
This implies that futures trading is a driving force to increase the price of bitcoin and might continue to do so.
Before considering the future of bitcoin prices, you should take into account:
- Bitcoin’s supply and demand patterns
- New laws and regulations and other news events that might affect pricing. Eg, South Korea’s ban on bitcoin futures trading.
- Deliberate market manipulation.