Bitcoin futures is an important aspect of cryptocurrency investment, it enables investors to speculate on Bitcoin price without actually having to own Bitcoin. Here are the basics about it.
What exactly are futures?
Simply put, futures can be said to be an agreement to buy or sell an asset on a specific future date at a specific price. Once the futures contract has been entered, both parties involved must buy and sell at the agreed-upon price, notwithstanding what the actual market price is at the agreed-upon date.
The essence of futures is not necessarily to maximize profit. It’s actually a risk management tool, mostly used in financial markets to shield against the risk of fluctuating prices of assets that are bought and sold on a regular basis – such assets may be particularly volatile. Futures exchanges act as the intermediary on which futures contracts are negotiated and traded.
How do futures contracts work?
One can take two different positions on a futures contract: long or short.
If one takes a long position, then one agrees to buy an asset in the future at a specific price when the contract expires. When one takes a short position, then one agrees to sell an asset at a specific price when the contract expires. For instance, an airline can shield against rising fuel prices by entering into a futures contract. If jet fuel sells for $2 per gallon. An airline anticipating an increase in fuel price buys a three-month futures contract for 1,000 gallons at current prices. The contract is, therefore, worth $2,000. If at the expiration of the futures contract, the jet fuel sells for $3 per gallon, the airline has saved $1,000.
The supplier on the other part will happily enter into a futures contract so as to ensure a steady market for jet fuel, even when prices are high. Suppliers are also protected by the same contract if the fuel price unexpectedly drops. As such, both parties are protecting themselves against the volatility of fuel prices.
Some investors speculate with futures contracts rather than use it as a protection mechanism. These investors will deliberately go long when the price of a commodity is low. As prices rise, the contract becomes more valuable, and the investor could decide to trade the contract with another investor before it expires, at a higher price.
What then are Bitcoin futures?
Since futures are not only for physical assets; they can be traded on financial assets as well. With Bitcoin futures, the contract will be based on Bitcoin price and speculators can place a “bet” on what they believe Bitcoin price will be in the future. More so, Bitcoin futures enable investors to speculate on Bitcoin price without actually having to own Bitcoin.
Bitcoin Futures has two main benefits. First, Bitcoin futures can be traded on regulated exchanges, regardless of the fact that Bitcoin itself remains unregulated. This is good news for those who are concerned about the risks associated with the crypto industry due to lack of regulation. Second, Bitcoin futures allow investors to still speculate on the price of Bitcoin even in areas where Bitcoin trading is prohibited.
How do Bitcoin futures work?
Bitcoin futures work exactly on the same principles as futures on traditional financial assets. They work by predicting whether Bitcoin price will go up or down, speculators will either go long or short on a Bitcoin futures contract.
For instance, if an investor owns 1 BTC priced at $18,000 (hypothetic value) and predicts that Bitcoin price would fall in the future, to protect themselves, this investor can sell a Bitcoin futures contract at the current price, which is $18,000.
Close to the expiration date, the price of Bitcoin, along with the price of the Bitcoin futures contract, might have dropped. The investor can then decide to buy back the Bitcoin futures. Say the futures contract sells for $16,000 close to the settlement date, the investor has made $2,000 and therefore protected their investment by selling high and buying low.
Contrariwise, if the futures contract sells for $20,000 close to the settlement date, the investor has lost $2,000. This is basically how Bitcoin futures work; however, the exact terms of each future contract may be more complex depending on the exchange, which will include minimum and maximum price limits.
What do Bitcoin futures mean for Bitcoin price?
In the short-run, Bitcoin future pushes Bitcoin price upwards as the overall interest in the Bitcoin rises.
For instance, a day after Bitcoin futures were launched on the Chicago Board Options Exchange (CBOE), for the first time on a major regulated exchange, Bitcoin price rose by about 10 percent to $16,936.
Likewise, when the Bitcoin futures were launch of on one of the world’s biggest exchanges, CME, the price of Bitcoin spiked through the $20,000 barrier.
In the long-run, though the impact of Bitcoin futures on Bitcoin price is harder to predict, however, there is likelihood that it will continue to boost the Bitcoin price.
How Do Bitcoin Futures raise the Bitcoin price?
As Bitcoin futures can be regulated on public exchanges, it gives people who were previously skeptical as a result of Bitcoin’s lack of regulation, the confidence to invest. Besides, there are likelihood that institutional investors would offer Bitcoin futures to their clients as a viable investment option.
More so, Bitcoin futures bring more liquidity to the crypto market, making Bitcoin easier to buy, sell and trade, and therefore much more lucrative. In a nutshell, it opens up the Bitcoin market to a wider investor base, including countries where Bitcoin has been banned. Since Bitcoin futures balance out price fluctuations, it could also make the Bitcoin price becomes less volatile.
Where can Bitcoin futures be traded?
Bitcoin futures can be traded in two separate markets. The first option is on selected cryptocurrency exchanges, which include BitMEX and OKCoin. The second option is on public regulated exchanges.
Bitcoin futures was first launched by CBOE on 10th December, 2017. The Chicago Mercantile Exchange (CME) followed with its launch on 17th December – though trading started on the 18th. Brokerage firms like TD Ameritrade and JP Morgan have also expressed their interest to allow access to these markets.