Bitcoin futures contracts offer traders greater flexibility and access to leverage for greater exposure.
Futures contracts are a type of financial derivatives that allow speculation on the price movements of assets such as commodities, stock indices or cryptocurrencies, such as bitcoin.
Key facts:
- Bitcoin futures contracts allow speculation on the price of bitcoin at a future date.
- The standardization of bitcoin futures contracts is set by each exchange.
- In addition to bitcoin futures, perpetual futures and options contracts are also traded.
- The different types of futures contracts allow traders to bet on the upside or downside.
In the case of bitcoin (BTC), a futures contract allows you to profit from fluctuations in its price, at a future date agreed upon by the parties, without necessarily having to purchase and hold BTC.
1. Bitcoin Futures Contracts
Bitcoin futures contracts are the technical name for the best-known derivatives of this cryptocurrency. For simplicity, some also call it bitcoin futures. Bitcoin (BTC) futures are derivative contracts, or bitcoin financial instruments traded on an exchange, in which the terms and conditions of future delivery of BTC are established.
A bitcoin Futures Contract is a legal agreement to sell or buy BTC, at a predetermined price, on a specific date in the future. This type of derivative is usually traded on a futures exchange, although major exchanges have incorporated dedicated futures trading units. Among the exchanges specialized in futures, which included bitcoin futures in their offerings is the Chicago Mercantile Exchange (CME), but there are other exchanges dedicated to bitcoin futures and other cryptocurrencies such as Deribit, Huobi and BitMEX, among others.
The buyer of a futures contract acquires the obligation to purchase and receive the specified amount of BTC when the contract expires. The seller of the futures contract acquires the obligation to sell and deliver the specified BTC on the expiration date.
The standardization of bitcoin futures contracts is determined by each futures exchange. For example, bitcoin futures contracts on the Chicago Mercantile Exchange (CME) are for 5 bitcoin and are quoted in US dollars (USD). There is another type of contract called bitcoin microfutures, which was introduced by CME in March 2021, where each contract corresponds to 0.1 BTC, as reported by CryptoNews.
There are two types of bitcoin futures contracts on Binance: those denominated and settled in Tether (USDT) and those denominated and settled in BTC. For those denominated in BTC, each bitcoin futures contract costs $100, which determines the specific amount of that cryptocurrency associated with each contract at the time of purchase. The maximum exposure allowed to a trader on Binance, through bitcoin futures contracts, is 1,000 BTC.
As an example of the diversity of bitcoin futures contracts available from different derivatives exchanges, one of the contracts offered by BitMEX is equivalent to 1 US dollar of bitcoin. It is denominated in USD and settled in BTC. A minimum of 100 contracts must be subscribed, with a maximum of 1 million contracts.
First bitcoin futures contracts
The first bitcoin futures contracts were traded on the Chicago Mercantile Exchange (CME) on December 17, 2017. Subsequently other exchanges started trading bitcoin futures contracts and also futures of other cryptocurrencies, such as Bakkt, CBOE. Also conventional cryptocurrency exchanges diversified their product offering towards bitcoin futures contracts.
2. Other forms of bitcoin futures
In addition to the bitcoin futures contracts described in the previous section, there are so-called perpetual bitcoin futures, which do not have an expiration date and can be held for as long as desired. There are also those with the name of futures option contracts, binding conditions different from those deprived in a conventional futures contract.
Perpetual bitcoin futures
Perpetual bitcoin futures, also called perpetual swaps, use a different mechanism to enforce price convergence at regular intervals. This is known as the funding rate, which is defined as the periodic payments between traders to bring the price of the perpetual futures contract closer to the prevailing BTC price, or spot price.
For example, if a perpetual swap contract is trading below the spot price, the funding rate will be negative. This implies that holders of short positions, who are betting on the downside, must pay holders of long positions.
If, on the other hand, the contract price is higher than the spot price, the financing rate will be positive and the holders of contracts with open long positions must pay the holders of contracts with open short positions.
In both cases, the financing rate promotes the opening of new positions that can bring the contract price closer to the spot price. In other words, traders will tend to promote contracts priced closer to the spot price in order to minimize the payments to be made.
Bitcoin options contracts
Finally, a third type of bitcoin futures contracts are options contracts, which allow taking short and long positions, with the difference that traders acquire the right, but not the obligation, to buy or sell bitcoin at a specific price or strike price. There are two types of bitcoin futures options: put options and call options.
Bitcoin put options give the right, but not the obligation, to sell a specific amount of BTC at the price stipulated in that option within a certain time frame. A bitcoin put option is acquired when the trader expects the price of bitcoin to go down.
A bitcoin call option gives the right, but not the obligation, to buy a specified amount of BTC, at a specified price, within a specified time frame. In both types of options, a commission is paid for the purchase, called a premium. In the case of a call option, if the price declines, the most the trader can lose is the value of the premium.
3. How does bitcoin futures trading work?
Bitcoin futures trading has a distinctive feature compared to spot trading in that it does not require buying, selling or holding BTC. Instead, futures traders buy or sell futures contracts that represent the value of bitcoin at a certain date in the future.
Although futures contracts can be denominated and settled in fiat money, there are some contracts that are settled in BTC, although this is not a necessary condition for bitcoin futures trading.
Bitcoin futures allow investors to speculate on the future value of that cryptocurrency. For example, traders can open a long position and bet on a price increase, or they can open a short position if they expect that the price of BTC is going to register a pullback.
The use of leverage in futures contracts
One of the outstanding benefits of bitcoin futures is the use of leverage. Leverage is the use of borrowing to increase exposure to bitcoin, which allows for greater capital efficiency.
In a 10x leverage, one accesses 10 times one’s own capital to invest in bitcoin. If you have, for example, USD 100 in an exchange account, you can open a USD 1,000 position in BTC.
Just as leverage can increase a trader’s profits, it can also amplify his losses if the bitcoin price does not move in the desired direction. For this reason, caution is advised when using leverage levels. For beginning traders, a conservative leverage of 2x or 5x is most appropriate.
Leverage as a hedge
Leverage, on the other hand, allows futures to be used as a defensive hedge for portfolios. In the event that bitcoin underperforms or moves in the opposite direction to that expected in the spot position, a futures transaction can hedge that outcome to offset the loss. In other words, a short exposure in the spot market can be hedged with a long exposure in the futures market, or vice versa.
What are the risks of futures contracts and how to minimize them?
It has already been mentioned that the use of excessive leverage increases the risks of bitcoin futures trading. One of the techniques recommended as part of the risk management of futures contracts is the use of stop-loss orders, which automatically exit positions when they reach a certain percentage loss.
It is advisable to set a strict limit when starting to invest in leveraged futures contracts. For example, limit investments to between 1% and 5% of your capital to open a futures position. Some exchanges offer practice platforms to learn more about futures trading in real time, without risking real money.
4. Expiration of bitcoin futures contracts.
When someone buys a bitcoin futures contract and holds it until the expiration date, it will be settled according to the terms of the contract. The buyer will receive from the seller the agreed amount of BTC (physical settlement) or the cash equivalent, at the agreed price.
However, the flexibility of bitcoin futures trading allows for several ways to trade the contracts. In addition to settlement at the end of the contract, the buyer has other options. He can roll over the contract to another future date, or he can exit the position before the specified date, as specified in the figure below.
The chart shows the different stages of the bitcoin futures contract when settlement takes place on the expiration date (left side) and when the contract is settled before that date (right side). A third option is the rollover of the contract to be settled on a date later than the original expiration date.
5. Where bitcoin futures are traded: main exchanges
According to daily volume traded daily, the top five bitcoin futures exchanges are Binance, MEXC, BTCEX, OKEx and Bybit, in figures from CoinMarketCap. The latter holds the lead in open interest, which is the value of open contracts that are pending settlement. After Bybit, the exchanges ranked by open interest are CoinEx, Binance, CoinTiger and Bit.com.
In addition to those mentioned, CME, the largest exchange trading futures of different asset classes and commodities, is notable for being the first to trade bitcoin futures, in December 2017. Among other exchanges with bitcoin futures offerings are Bitmex, Kraken, Huobi, Deribit and Gate.io.
The chart below shows the monthly bitcoin futures volumes, in billions of dollars, on the 12 major exchanges. The chart uses Anglo-Saxon nomenclature and the volumes are indicated in “trillions” of dollars, but they are billions.
Monthly BTC futures volumes in billions. Source: The Block.
The monthly volume chart since March 2020 shows a peak of USD 2.42 trillion in May 2021. Also visible is the downward trend in 2022, which surpassed USD 1.3 trillion in January, to end August at USD 467 billion. This represents a 64% drop in BTC volume in 8 months.
6. Why bitcoin futures contracts are important
The most significant advantage of bitcoin futures contracts is that they offer exposure to bitcoin in a regulated environment. For investors, the cryptocurrency market is not sufficiently regulated. In the case of bitcoin futures, as explained below, there are specific regulations, which are not seen in the spot markets for that cryptocurrency.
As mentioned above, the popularity of bitcoin futures contracts is associated with the fact that they can be used in conjunction with bitcoin spot trading as part of a risk management strategy.
Bitcoin futures contracts are regulated by the Commodity Futures Trading Commission (CFTC) in the United States. CFTC can be translated as Commodity Futures Trading Commission. This is the regulatory body that has exclusive jurisdiction over futures markets in the United States, which is why many see futures as a safe way to invest in bitcoin for the first time.
