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What Is Bitcoin Futures?

Derivatives are an important component of any mature market, and cryptocurrency is no exception. One of the first derivatives on crypto exchange was bitcoin futures. How do these contracts work, what is the special use with bitcoins, and where can cryptocurrency futures be traded?

What are futures?

Futures –  a type of forward contract (a future delivery transaction). Under the futures agreement, the seller undertakes to sell and the buyer buys a certain quantity of goods in the future at a value fixed today. For example, according to Bitcoin Futures, the seller must deliver one Bitcoin to the buyer in a month’s time, at a cost of $50,000, and whether that Bitcoin is worth $70,000 or $30,000 in a month’s time. 

Futures appeared in the United States in the middle of the last century in the form of grain contracts. These contracts guaranteed farmers that they would receive funds for the next planting, regardless of future grain price fluctuations, the Futures quickly spread to almost all commodity markets, and then stock and other asset contracts.

What are futures for?

The original purpose of the futures was to protect the buyer and/or seller from future price fluctuations of a commodity or goods, that is, futures were needed to hedge risks. For example, if a trader buys a stock but is not sure that it will grow, it can simply open a futures share and, if the value falls, sell it at the start price. 

However, with the advent of futures on exchange assets (and even futures on derivatives), they were used for speculative purposes. For example, if you open a futures contract not to sell, but to buy a stock, you can get an asset that will be worth more than the futures contract. That is, depending on the type of contract, traders can earn both on the growth of the market (opening cheap futures to buy) and on the down (opening expensive futures to sell). 

What kind of futures?

Futures can be classified according to a number of criteria, but for a cryptomarket the most important indicators are delivery and executive time. On delivery, futures are divided into:

  • Delivered – when the futures are performed by a real delivery of the asset. That is, when Bitcoin Futures is closed, the seller must actually give the Bitcoin.
  • Undelivered – Futures are executed in fiat equivalent. So the seller does not transfer bitcoin to the buyer, but its value on the closing date of the futures. 

In time of execution:

  • Fixed-term – it predetermines the exact date of completion (date or day). An Fixed-term futures event is held and closed on a fixed date, regardless of the owner’s wishes. 
  • Indefinite – have no deadline and are executed on the nearest fixed date (for example, the last Friday of the month) upon the holder’s request. That is, in principle, an open-ended future can be kept open as long as possible. Even if it closes automatically on a fixed day, the next day the exchange will open a new futures position for the owner without real execution.

Indefinite and undelivered futures are the most common on crypto exchanges, as it is more convenient to trade and can be used to earn on changing the price. 

What’s the features of bitcoin futures?

Legally and technically, bitcoin futures are no different from futures contracts for any other commodity or asset – the same terms and conditions and the same execution mechanism. The main differences are due to the economic characteristics and nature of Bitcoin:

  • Low minimum futures cost – for example, a minimum futures price per silver is 1,000 ounces (several thousand dollars), while crypto exchanges offer bitcoin futures worth 10 dollars. 
  • Speculative nature – derivatives in the crypto-market are used more for profit on volatility than for risk hedging, which is related to the characteristics of the cryptomarket. 
  • Most of these contracts are in the form of undelivered contracts. As traders tend to capture profits, they do not need Bitcoin. Futures execution take place in a fiat.

In general, bitcoin futures are more affordable than futures for other products or raw commodities. Classic futures are traded on stock exchanges through intermediaries – brokers, while bitcoin futures are available on crypto exchanges, where they can be traded directly (sometimes even without verification).

What is a futures specification?

A futures contract is a forward contract with concrete requirements. The futures published on any exchange must have a standardized description that includes a number of contract details – that description is called a specification. Main items of specification:

  • lot size
  • step of price;
  • executing date;
  • initial margin
  • minimum contract value.

Additional information can also be included, such as the closing time of daily clearing (when determining the variation margin) and the general trading rules for futures on the site. For example, the Bitcoin Futures specification on the Chicago Commodity Exchange looks like: 

If the futures are a contract, then the specification is the terms of the contract under which it will be traded and performed on a concrete exchange. 

What is an expirations of futures?

A future is in fact a contract for future delivery and, like any contract, it comes into performance. A futures contract may be executed quarterly or monthly, depending on the asset and the exchange at which it is traded. Performance may take the form of:

  • physical delivery of an asset – for example, if you have a physical supply of bitcoin futures, it is performed by transferring to your bitcoin wallet by the seller. 
  • currency settlement – similar to the example above, the seller should not transfer the bitcoin, but a fiat value at the time of execution in the buyer’s stock account. 

Under the established market rules, futures contracts on most exchanges are performed on the third Thursday of each month (or the last month of the quarter). On the cryptocurrency market, the most common is the last Friday of the month. The month of execution is usually included in the futures name (after the ticker of the asset) and is denoted by the letter of the Latin alphabet. 

What is the initial, supporting and variable margin?

We were already seeing the concept of margin when we were talking about trading with credit leverage. Futures trade also requires margin and performs roughly the same function as in the credit leverage – deposit. When a futures contract is opened, there are three types of margin that are related to each other: 

  • The initial fee – is the amount of the deposit required for the futures opening. It is generally set as a percentage of the value of the contract. For example, the initial margin can be 1 percent of the value of the contract. An initial margin is needed to ensure that the exchange is able to pay if one of the parties fails to complete the terms of the contract (the exchange actually pays the second part).
  • Variation – the difference between the initial margin and the account balance at the end of the day. So if you’ve discovered a $1,000 bitcoin futures with $10 as a margin, and by the end of the day, the course had fallen and the contract was now worth $995 instead of $1,000, that difference would be written off your margin account. At the end of the day, if the futures price is higher, the trader will fix on the margin account as a profit, and if the margin is lower than the minimum level, the margin-call is starting. 
  • Supporting is the negative difference between initial margin and variation margin. In fact, the amount a trader would have to contribute to bring the margin to a minimum level and maintain an open futures position. In the above example we said that when a course falls, 5 dollars will be deducted from the margin. Now, that $5 bill needs to be paid to the exchange to keep the margin at the right level. 

In practice, the situation is more complicated, besides the initial margin is there minimal margin also used – the minimum level at which a trader must maintain a margin account. And the minimum margin is usually lower than the initial margin, which allows the futures to be kept open in a certain price corridor without the risk of margin-call. 

What is contango and backward?

Futures and assets to which they are related are not always correlated – the price of futures also includes the reward for the seller, the cost of transporting the goods (not for cryptocurrencies) and other aspects. Therefore, there are market situations where the spot and futures asset are different in value. This difference can be expressed in:

  • Contango – a situation where the value of a futures asset is higher than the value of a spot asset and in the future futures will be higher than the current rate. In fact, the difference between the spot rate and the derivative is the reward that the buyer pays to the seller for being able to receive the goods later. It’s relevant if you buy bitcoin futures and expect it to be worth more in a month than it is now.
  • Backwardation – is a situation where the value of futures is lower than the value of a spot asset, and in the future futures are expected to be lower than current rates. In fact the seller already pays a reward for being able to sell the goods now until the prices have fallen. 

In commodity and goods markets, Contango and Backwardation are cyclical situations, depending on the seasonality and market cycles of supply/demand. Ultimately, the value of the futures and spot asset is equalized.

The cryptocurrency market is somewhat different, since there is no such thing as a spot asset. In fact, the Contango and Backwardation of bitcoin futures is simply a reflection of traders’ expectations. Thus, if holders of indefinite futures expect a fall, they begin to sell it, which causes the derivative price to fall and may even fall below the spot. 

Where can you trade bitcoin futures if you don’t have much money?

In the above specification from the CME, the minimum size of a futures contract is 5 bitcoins. CME is a regulated commodity exchange that can provide traders with a number of guarantees and advantages, but a contract of 5 bitcoins based on the current course, even for mid-level investors is unrealistic, not to mention small traders.

Binaryx does not yet trade cryptocurrency derivatives because it is a complex exchange tool that is irrelevant to beginners. However, if our users express a desire to work with bitcoin futures and we see a real need to add this contract, this function will be implemented. 

The minimal cost of cryptocurrency futures on Binaryx will make them available even to small traders, allowing our users to hedge risks and use this tool to maximize profits. 

How can futures affect the price of bitcoin and the cryptomarket in general?

The first appearance of bitcoin futures on CME was a landmark event for the entire crypto market, cose it demonstrated that traders and investors perceive cryptocurrency not as entertainment for geeks, but as a real and profitable asset. Since then, futures have had a significant impact on cryptomarket in several directions:

  • Trading – Bitcoin became more attractive to traders as they were able to speculate not only on growth, but also on the decline of the market. Futures offered the opportunity to increase revenue even in short-term intra-day trading.
  • The distribution of capital – is rather a negative factor, as some of the capital from the cryptocurrency has flowed into futures contracts. If the capitalization of bitcoin is included in the total capitalization of the market, then the amount invested in futures is not included. However, the reallocation of capital partly compensates for the attraction of investment from new traders and investors who expected derivatives to emerge in the market.
  • Price volatility – futures have become one of the indicators of traders’ expectations and influence the spot prices of an asset. For example, if holders of indefinite contracts begin selling or demanding them on a massive scale, it is a clear signal that prices will fall in the future. Conversely, the growing open interest (the sum of the open futures) talking about  the bull market.
  • Market status – without risk-hedging instruments, large investors are slow to invest in the high-volatility market assets that Bitcoin is. The introduction of futures on a regulated exchange has made investment safer and risk manageable, which is important for mass adoption of bitcoin. 

In summary, cryptocurrency futures have consolidated the transition of digital currencies (primarily bitcoin) to a new economic level. In addition to market strength, Bitcoin has also grown in popularity among institutional investors and speculative traders. Futures expanded the functionality of bitcoin and other cryptocurrencies, and gave push to the development of derivative cryptomarket on the native market exchange.

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