This post aims to explain the most basic things about (crypto) futures.
What are Futures?
A futures contract (short: futures) is a standardized agreement to transact an asset at a predetermined price at a specified time in the future.
Ok, what? Let's put it in easier words: A futures contract lets you buy or sell the underlying asset at some point in the future for a price you know today. So, basically instead of buying or selling the commodity directly you are buying a contract representation of the commodity, which will be settled in the future. This way, you can either speculate on or hedge against a change in price.
Why don't just buy today?
Valid question. Futures were originally developed to facilitate trading commodities (raw material like corn, grain, etc). If you'd buy corn today you'd carry the risk that it gets rotten, or something else happens to it and you'd have to pay for storage costs. If you buy a contract that lets you buy it at some point in the future for a price you know today you can calculate plan with the commodity without any risks of price changes.
Distinguishing feature of futures compared to bilateral agreements between the buyer and seller (which is basically called a forward) is:
Futures contracts for an underlying asset are standardized. The quality and the quantity of the asset, the delivery location, and delivery date are defined. Therefore, each contract is easily tradable between multiple entities. The contracts therefore facilitate trading the asset on an exchange. That's because every contract is exactly the same and you don't need to worry about handling the asset at the time of buying/selling the contract.
The CME (Chicago Mercantile Exchange—the world greatest futures market) offers some basic informational resources about futures.
Example
You love apples, it's Fall and apple season. So, apples are cheap (2$). You know that the last years apples were considerably pricier during summer (4$). But you want to eat apples all year long for a low price. Therefore, you could go and buy apples futures contracts.
On the apples futures exchange an apples futures contract has the following characteristics: One contract stands for the delivery (and acceptance of the delivery) of 500 edible green apples at the last Friday of April at a specific warehouse. If you buy one contract it'll cost you $1,000. If you buy the contract:
The farmer
- locks in a profit today
- hedges against a future price decline because of some event (e.g. someone inventing a sort of apples which can be grown all year long)
- has the obligation to deliver the apples at the specified date and location.
- But he gives up the chance of a possible higher future price.
You
- have the obligation to take the delivery of the apples at the specified date and location
- know the price of your apples in advance and possibly save some money because of a higher price in the future (hedge)
- could sell the apples in May for $4 (if it raises to that price again) and make a profit (speculate).
- But you would loose money if apples would be worth less than $2 in the future.
Delivery and cash settlement
A futures contract can be settled at its expiry/due date in two ways: Delivery or cash settlement. In the apples example above I assumed a delivery settlement at the expiry of the contract. That means the (physical) goods will be delivered at (or a specified date after) the due date of the futures. This is typical for all commodity futures.
If you buy a cash settled futures contract the contract is settled in cash at its expiry date—and no commodities are delivered. This is typical for financial asset futures.
Crypto Futures
The crypto space has some specific characteristics when it comes to futures trading. Basically, all crypto futures are cash settled. Lets take the Binance Futures as an example. Binance has two types of futures:
- USDT-M Futures
- COIN-M Futures
The M stands for margined. So, USDT margined futures are bought using USDT and all profits and losses are denominated in USDT. Coin margined futures are bought using the corresponding coin (e.g. BTC, EHT, etc) and all profits and losses are denominated in that coin (BTC, ETC, etc).
Even though it seems that the COIN-M futures are delivery settled that is not the case, since you already buy the futures using the actual asset. That's why it's (crypto) cash settled. If the contracts were truly of a delivery type you'd buy them with USD(T) and get e.g. BTC at the expiry date.
Why can't I just buy Bitcoin?
You could. USD(T) cash settled futures have the advantage that you can profit from e.g. BTC's price movement without the risk (theft, loosing, etc.) of actually holding BTC.
A BTC cash settled future (COIN-M/inverse futures) has its own benefit:
Say you buy contracts for 0.2BTC. Price moves 10% in your favor and you sell the contracts. Not only is your 0.2BTC 10% more worth but you gained additionally 0.02 BTC. At the end you got 0.22BTC which are more worth. So, with COIN-M/inverse futures you've got the possibility to trade your BTC holdings up until you got your first whole BTC.
Furthermore with crypto futures you can short BTC, ETH, etc. without actually selling them. So, you can profit from crypto prices moving up and down. With COIN-M/inverse futures you can stack up your cryptos even though the price declines for a moment.
What is hedging and what are the benefits?
A short and incomplete example: Say you got 1 BTC and the price is at around 60k USD(T) again. You think the price may drop again but don't want to have less money after the price drop. So you could sell some futures at a price of 60k. If the price drops your BTC are less worth but you made profit with your futures. If you chose a good hedging ratio the futures profit compensates the loss of the price drop and you "didn't" loose.
Where can I trade crypto futures?
If you live outside the US I recommend Binance Futures trading platform. Use the link or the referral code 73893145 to save 10% on trading fees.
If you live within the US I recommend ByBit. Use the link or the referral code 17224 to save 10% on trading fees.
Generally, both exchanges are stable, reliable, and have good reputation. Binance is the biggest crypto exchange and has a lot of trading pairs. ByBit is cheaper when it comes to commissions.
FAQs
What's the difference between an inverse and a vanilla futures contract?
Generally, a futures contract on BTC is quoted in USD. So, BTC is the base currency and USD is the quote currency.
Vanilla is just another word for standard. So, vanilla futures contracts are "standard" futures contract. That means in this context that typical/vanilla futures contracts denominate the margin and profit/ loss in the quote currency. Thus, a vanilla futures on BTC that is quoted in USD is margined and settled in USD. On Binance the USDT-M futures are vanilla futures.
An inverse futures contract, on the other hand, denominates margin and profit/loss in the base currency. Thus, an inverse futures on BTC that is quoted in USD is margined and settled in BTC. On Binance the COIN-M futures are inverse futures.
This is not financial advice. This post references an opinion and is for information purposes only. It is not intended to be investment advice. I am not a licensed and/or registered investment advisers. Seek a duly licensed professional for investment advice. Cryptocurrencies and its derivatives are highly speculative and volatile assets. Only trade with money you can afford to loose.
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