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It has been an eventful few months within the crypto market. Most cryptocurrencies, Bitcoin (BTC) included, have surged to new highs before crashing back down. This volatility is not unusual for the sector and in it lies excellent opportunity too.
While some crypto enthusiasts sweat over Bitcoin’s unpredictability, others see possibilities to make a killing. And they’re doing that through Bitcoin futures, a speculative BTC trading strategy that utilizes the volatility of the crypto.
So what are Bitcoin futures? How do they work, and most importantly, how do they impact BTC prices? If you’ve had any of these questions, then you’re in the right place. This article will provide you a thorough understanding of Bitcoin futures, helping you draw the relationship between them and BTC prices. But before we go into that, let’s first have a look at what Futures are.
What are Futures?
Also known as Futures Contracts, Futures are a legal agreement binding parties to trade in a given asset or security at a pre-set price and date in the future. This price, known as the forward price, is what the buyer pays when the contract expires regardless of the market prices at that time.
The underlying asset is either a commodity or another financial instrument. The agreed date is known as the delivery date. And on it, the seller commits to provide the commodity or security they’re offering. Similarly, the buyer guarantees to take possession of assets.
Futures were intended to cushion the trading parties against the risks of fluctuating prices and exchange rates. They achieve this by settling the prices before future transactions.
The parties can take either long or short positions. A long position is holding on to an asset believing that it will appreciate. On the flip side, a short position entails selling off the asset believing that it will depreciate. Futures are a common trading strategy in the stock market.
The Evolution of Futures Contracts in Cryptos
Bitcoin futures are an evolving area in the crypto industry. First, they came into existence in late 2017. Then, leading futures exchange platforms, the Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange(CME), offered them a regulated product.
Before then, exchanges would offer futures as an unregulated product. Today the market for futures has grown. You may trade in the product on one of the many exchanges offering them. Binance, Bybit, OKEx, and Deribit are a few of the popular ones.
How do Bitcoin Futures Work?
Bitcoin Futures are a type of derivative that allows traders to speculate on the future price of BTC while also managing risk. They’ve gained popularity as their introduction coincided with the explosion of cryptocurrencies like Bitcoin.
There is plenty of speculation about what these new tools mean for BTC prices long-term. Can they help stabilize volatility, or could they lead to even more dramatic swings? Here now, we look at their impact on BTC.
Like the traditional futures, Bitcoin futures obligate a party to trade BTC at a pre-agreed upon price, date, and time. In addition, they specify the quantity of Bitcoin the parties are trading with the contract size ranging from 50 up to 20,000 BTC. Thus, the volume available for trading varies with demand and supply as well as market volatility.
Futures are Speculative
These contracts work by specifying an agreed amount for BTC delivery between two parties. So if you’ve 100 BTC worth of BTC standing “futures” at $15K each, it would value your position at $150K.
BTC futures provide a way to speculate on increasing or decreasing BTC prices by buying and selling them. Thus, they allow you to “bet” against the price movement of Bitcoin without investing in it.
Futures Increase the Sell Pressure
The purpose is simple: when you buy into a contract at one point in time, you can – if your prediction turns out correct – buy Bitcoins cheaper than their current market value and sell them higher up within the contract’s lifespan, just like betting!
When Bitcoin futures contracts expire, the contract holder will either win or lose and receive a cash settlement. Consequently, these holders’ bets can significantly influence BTC’s long-term performance because they increase the selling pressure. As a result, more people liquidate their positions towards the contract expiration date to reap gains or cut losses.
BTC Futures Hedge Against Risk
Investors use BTC Futures because they allow buyers to hedge their risk before buying. Thus traders don’t need to worry about losing money if prices go up or down. They’ll already have hedged against losses when opening their positions, thus provides some stability for both small investors and big ones alike.
When you buy Bitcoin Futures, you’re “taking” long positions. This is because you believe that BTC prices will rise within this time frame; thus, you stand to profit. Conversely, if you take a short position, you believe that Bitcoin prices will fall during this time frame. Therefore, you’ll gain from the price fall.
How BTC Futures Affect the Price of Bitcoin?
All futures contracts acquire their value from their respective underlying. In the case of bitcoin futures, their prices rely on bitcoin spot prices, and any changes in the latter affect the former. This dependency puts the two moving prices in sync with each other, though there is a difference between the two.
So do Futures affect BTC prices?
Quantum Economics’ Shawn Dexter thinks so. According to him, derivatives enable investors to take risk-neutral transactions that they’d otherwise not access. Consequently, they have both long-term and short-term impacts on BTC’s price.
It may seem that futures don’t impact BTC’s spot prices because they don’t involve actual BTC sales. However, Dexter opines that they do affect them.
BTC Futures and Arbitrage
If someone were to buy a large volume of futures offered by an exchange, its BTC futures prices would rise. As much as this wouldn’t affect the spot prices, it would provide an arbitrage opportunity, drawing traders eager to cash in on the lower BTC spot prices. Consequently, BTC spot prices would rise.
Long Term Effects of Futures on BTC Spot Price
Over a more extended period, BTC futures affect its spot price significantly. This is because the contracts increase price stability while reducing risk. When this happens, BTC becomes bullish as it draws in large-scale investors. And from their investments, there’s increased liquidity too. In short, futures pull institutional investors as it enables them to hedge their investments.
How much of an impact futures contracts have on BTC prices remains debatable. One thing is clear, though; they do affect market demand on the crypto. On that score, one may rightly conclude that they impact BTC spot prices. Over the long haul, they infuse liquidity and, therefore, stability into the BTC market. All these results from the futures are allowing institutional investors to hedge their holdings against risk. Though speculative, they provide an opportunity to make massive gains trading BTC.