Futures markets have been in existence for the more mature asset classes, including commodities and equities for quite some time, however, Bitcoin futures launch is a major step towards the legitimisation of the most popular cryptocurrency.
What is Bitcoin Future?
Within a futures market, an investor is able to trade futures contracts, which involves the purchase of an asset class at a particular price with a settlement date set at some point in the future.
The underlying value of the futures contract for a particular instrument is then priced according to the actual asset itself, whether gold, crude, an index or individual stock.
Futures markets have been prevalent in the financial markets for many years, with the first modern era futures market reported to have been the Dojima Rice Exchange, launched in Japan in 1710. Some suggest that the London Metal Exchange that was founded in the 19th century traces back to the 16th century and that’s before considering 1750 BC’s Code of Hammurabi that allowed the sales of goods and assets to be delivered for an agreed price at a future date.
Futures contracts contain the details of the asset class in question together with the purchase size, final trading day, maturity date and exchange on which the contract is being bought or sold. Futures contracts are created based on demand and do not get automatically created in the marketplace, involving two parties, where one party is going long on an asset class, while the other goes short.
Upon expiry of a futures contract, the settlement is either physical, in the case of commodities, or via a cash settlement in the case of Bitcoin, though the futures contracts are likely to change hands on numerous occasions before expiry. It is important to note that the futures market is used by investors looking to hedge exposures to a particular instrument or by speculators, neither of whom are actually looking for physical delivery that is akin to the spot /cash markets.
As investors have become more knowledgeable about the markets and the influences on asset classes, the futures markets have become a guide for investors on the likely direction of commodities, stocks and indexes on a given day, with crude oil futures, gold futures and the the Dow Jones reflecting investor sentiment towards the respective instruments and the direction based on the flow of information that influences supply and demand dynamics.
For investors looking to hedge, there will already be some form of an exposure to the spot or physical and the futures markets allow the company or investor to protect the upside or downside with a futures contract.
As an example, airlines are well known to protect themselves against significant rises in crude oil prices, by buying a futures contract today with a specified price and delivery date in the future, on the assumption that oil prices will be on the rise over the period in question.
In this case, the airline is exposed to the cost fluctuations of crude oil as a physical but is looking to protect itself in the futures market. If crude rises in value by $20 per barrel over the year and the airline has a futures contract at $5 per barrel above the current price, the impact on earnings is significantly less than without the execution of the futures contract. In this example, the airline would be taking a long position, while the party obligated to deliver the crude oil will be taking a short position, as they are the seller, while the airline is the buyer. An airline is unlikely to take a short position in crude oil, as declining prices benefit the bottom line.
In contrast to investors or companies looking to hedge exposures, speculators will be looking to benefit from the price fluctuations of an asset class without actually having a physical exposure to the asset class in question. The incentive for a speculator is profit from the general direction of contracts decided upon by their outlook on supply and demand for the particular instrument.
In summary:
Hedgers can go either long or short. Short positions are taken to secure a price now in order to protect the hedger from declining prices in the future, while long positions protect against rising prices in the future.
Speculators go short on the expectation of prices falling in the future while going long on the assumption that prices will be on the rise.
With Bitcoin now having been in existence since 2009 and become a sizeable instrument by market cap comparable to some of the largest listed companies on the U.S equity markets, it comes as a little surprise that futures exchanges have moved ahead on offering investors with the option of Bitcoin futures contracts.
For Bitcoin, miners will receive some relief from the launch of the futures market, with the sizeable investments into mining equipment, not to mention exponential gains, needing some protection against price declines, while the speculator may be looking for the rally to continue and reach the stratospheric heights predicted by some in the marketplace, or in some cases, for the bubble to burst.
How to Buy and Sell Bitcoin Futures?
Bitcoin futures based on Gemini’s auction prices are available for trading
For those looking to enter the Bitcoin futures market, the first and fundamental question is whether the motivation is speculative or to protect current Bitcoin earnings from any downside.
Choice of exchange may be considered arbitrary, but it would be best to go with the exchange with the greatest number of futures contracts issued, as both will be considered liquid from an investor perspective.
As we addressed before, contract sizes differ on the respective exchanges as do margin requirements, so these are also considerations.
When looking to trade with margin, this is essentially the funding component of the trade executed on the futures exchange.
As investors will not actually own Bitcoin itself, there is no need for the full value of the purchase to be paid in advance of the contract expiry date. In the event of an investor holding a contract until the expiration date, the amount paid, if out of the money, is limited to the difference between contract price and the actual price. The margin is placed on a margin funding account as collateral for the trade.
In addition to the collateral, also referred to as initial margin, investors are required to meet Mark-to-Market calls during the duration of the futures contract.
The Mark-to-Market (“MTM”) margin is the difference between the cost of the position held and the current market value (“CMV”) of the position. In the event of a loss, the exchange will fund any margin shortfalls stemming from a MTM call from the investor’s margin funding account. The reverse is also possible, where the exchange funds the account where the investor has margins in excess of the required amount.
In the event that the margin funding account falls below acceptable levels, the investor will then be required to fund the account to meet future MTM requirements.
As we mentioned above, contract sizes between the 2 exchanges are different.
Final settlement on both exchanges is in U.S Dollars, with no actual Bitcoins held during the duration of the contract that requires settlement.
With futures contracts being a 2-sided market, involving a buyer and a seller, counterparty risk on the final settlement is absorbed by the respective clearing houses and not the party in the money.
It’s worth noting that, while those looking to hedge Bitcoin’s value are likely to hold futures contracts through the expiration, speculators are likely to be buying and selling Bitcoin ahead of expiration, taking advantage of daily movements in response to market noise.
For this reason, market liquidity is particularly important for those holding futures contracts as an inability to find a buyer can have quite dire consequences to the futures market and the price of Bitcoin itself.
How Can Bitcoin Futures Affect Bitcoin Trading?
The gains have come off the back of Bitcoin futures seeing an uptick in value above Bitcoin’s actual value at the time of launch of each of the respective exchanges.
With the general theory being that the smarter institutional money is going into the Bitcoin futures market, investors in Bitcoin will be looking towards the futures market as a guide to the future direction of Bitcoin, based on information available in the marketplace.
Increased appetite for lower prices would see the value of Bitcoin futures contracts decline, which would likely lead to price declines in Bitcoin itself.
When we look at the Dow mini or the S&P500 futures, daily movements have a material impact on the direction of the main indexes each day, barring the arrival of new information to which investors respond during normal trading hours.
For now, the number of contracts is considered relatively small and investors may take less direction from the respective exchanges, but we will expect the number of contracts to grow over time and provide some idea on which direction Bitcoin will take on a given day.
Exchange to choose
If you have a interesting in trading Bitcoin, Ethereum, EOS or other cryptocurrency futures in a professional exchange, JEX Exchange would be a good choice.
It’s the leading Bitcoin futures & options trading exchange in the world.
It's official website is as follows www.jex.com
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