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From spot trading to staking and now cryptocurrency futures, investments in the crypto space are increasingly being diversified-a move aimed at reducing risks and increasing profitability. Many crypto traders are increasingly engaging in trading crypto futures, which took the crypto space by storm around December 2018. A report by Tokeninsight revealed that the combined total trading volume in the cryptocurrency spot and futures markets in Q1 2020 amounted to roughly $8.8 trillion. This figure represented an enormous 314% quarterly increase for futures trading and 104% for spot trading from Q4, 2019. The downline is that futures trading has become a profitable trading practice in the cryptocurrency space; thus, any avid trader should be keen to understand Bitcoin & crypto futures. Here is a comprehensive guide.
Introduction to Bitcoin & Crypto Futures
For a broad definition, Financial futures refer to a financial instrument that specifies buying or selling a financial asset between two parties for a predetermined price and a precise date in the future. Bitcoin futures are futures contracts that enable traders to speculate on Bitcoin’s price without actually owning bitcoin. Once a futures contract is set or agreed upon, counterparties are required to fulfill the terms of the contract upon expiration, either by selling or buying the asset at the agreed price.
In futures trading, traders assume two positions: long or short. A long position requires that the trader buys the underlying asset in the future at a specific price. On the other hand, a short position requires that the trader sells the underlying asset at a specified price upon the contract’s expiration in the future. Crypto futures contracts, also referred to as derivatives, are traded on cryptocurrency derivatives exchanges regulated by the Commodity Futures Trading Commission (CFTC).
Crypto Futures Contracts- A Short History
While it may appear like crypto futures contracts hit the crypto space just the other day, it has been around for quite a while, since 2011. Bitcoin derivatives contracts were the first crypto futures launched in 2011 by ICBIT. The platform supported Bitcoin Futures in the form of limit orders and arbitrage on Bitcoin. With time, Okex joined in and started offering Bitcoin futures contracts. Crypto Futures witnessed a massive growth when BitMex started offering perpetual swaps – cryptocurrency futures without an expiry date.
However, crypto futures growth was hindered by an influx in scammers, market manipulations, and platform vulnerability, which deterred institutional investors from taking up crypto futures trading. Nonetheless, BitMEX’s perpetual contract gained widespread popularity and was replicated by numerous platforms.
In December 2017, the first institutional platform for trading cash-settled Bitcoin futures was launched by CBoe, which later has been abandoned. CME soon followed suit and launched its crypto derivative platform supporting Bitcoin futures.
Since then, Bitcoin futures have become the most widespread crypto futures with numerous cryptocurrency derivatives platforms supporting it. Other products, such as options contracts, have since been launched. Currently, Bakkt’s physically settled future and options contracts are quite popular among institutional investors.
How Does Cryptocurrency Futures Trading Work?
Trading crypto futures largely depends on selling and buying contracts based on the coin’s spot price. Traders, therefore, should adapt accordingly to constantly changing market sentiments. Crypto futures are employed in two major functions: hedging risk and speculating on the underlying asset’s price movement. To achieve these two purposes, crypto futures work by either longing or shorting.
Buying Bitcoin Futures (Longing)
Going long or longing is basically buying Bitcoin’s monthly futures during a particular contract period at any price position within the stated contract period. After purchasing the Bitcoin futures contract, traders could then sell at any price point before the contract expiration date to either make a profit or a loss depending on Bitcoin’s spot price.
Selling Bitcoin Futures (Shorting)
Going short involves short-selling Bitcoin futures, usually when Bitcoin’s price is expected to fall in the coming days. When a trader short-sells a Bitcoin futures contract, he/she is simply borrowing one Bitcoin futures contract from another trader and selling it, hoping to repurchase the contract at a lower price. Traders make profits via the price difference.
About Contract Settlement and Expiration
Contract settlement denotes the fulfillment of the legal obligations agreed upon in the contract. Depending on the contract agreement, the price of the underlying asset should be given to the contract holders on the specified date and at the prevailing market price at the time of settlement.
On the other hand, contract expiration refers to a date that marks the end of trading activity or when futures contracts expire. Before the specified contract expiration date, traders can either choose to end the trading activity or extend their open positions without closing the trade.
Since Bitcoin futures on most exchanges are cash-settled, traders usually receive fiat currencies equal to the value of the contract’s market price at the time of settlement.
Benefits of Crypto Futures Trading
Crypto futures trading offers several benefits that enhance trading profitability. Below are some benefits of futures trading.
- Hedging – Trading future presents an excellent opportunity for hedging digital assets to mitigate the risk of dwindling market prices. Traders can take a short position or buy some short futures to avert losses in the event of a bearish market trend.
- Speculate market trends – Crypto futures trading allows traders to speculate on market trends and earn lucrative returns. While you can still speculate on market direction by buying and holding, crypto futures offer a greater chance of racking in enormous profits without a great deal of risk.
- Leverage trading – Crypto future trading allows you to leverage your capital, meaning that you can invest more of what you have. Leverage trading comes in handy to lower the risk of storing cryptos in online exchanges, susceptible to security attacks.
- Even out volatility – For crypto merchants, price fluctuations spells doom for their businesses. Crypto futures help crypto merchants alleviate losses due to volatility, enabling them to focus on their main businesses.
Downsides of Crypto Futures
Despite the numerous benefits, trading crypto futures comes with several cons, as outlined below.
- High transaction fees – Exchanges that support crypto futures charge transaction and trading fees can sometimes be expensive.
- High volatility – crypto futures are influenced by market prices marking it challenging to predict market sentiment.
- High risk – Leverage trading coupled with futures presents high trading risks to traders. Therefore, it’s important to understand trading futures before engaging in such activities.
- Squeezes and manipulations– Crypto futures trading is full of market manipulations and unexpected long or short squeezes, which can cost traders their profits.
What are the best platforms for trading crypto futures?
Cryptocurrencies being highly volatile digital assets requires that traders manage risk to at least make substantial profits. Managing risk by buying low and selling high may not be effective or quite profitable since the price may continue rising after you sell high. Crypto futures offer a perfect opportunity to enable you to maximize profit margins by leveraging leverage to multiply your profits and lowering volatility risks when speculating on market directions. Bitcoin futures trading has grown significantly despite SEC’s regulatory hurdles, which has declined to approve Bitcoins ETFs citing regulatory and liquidity issues. Nonetheless, platforms such as Bakkt have enhanced Bitcoin futures trading among institutional investors- a significant step in the growth of cryptocurrency futures.