What you need to know about Bitcoin Futures
Bitcoin promises to bring a technological revolution that could sweep across the financial industry. Thanks to Bitcoin and blockchain technology, today we have a variety of innovative and secure ways to invest and trade. End-to-end transactions, decentralized networks, and digital ledgers are some of the stand-out features of the crypto market, which challenge the conventional mode of doing business.
It is no secret that trading in any emergent market comes with its own set of risks, but the specialty of the crypto market is that it has certain mechanisms in place to minimize those risks. Futures is one such mechanism that helps to safeguard against the risk of varying prices of assets that are traded on a daily basis.
What is a Futures contract?
Futures can be defined as an agreement between two parties to buy or sell an asset on a specific future date at a specific price. In futures or futures contracts, once the price of an asset is finalized for trading, it cannot be changed.
For example, John and Mark enter a futures contract, wherein they decide to trade their cryptocurrencies for a specific rate at a mutually agreed-upon date. When that date arrives they have to trade their digital assets for that specific rate, regardless of what the market price of their digital assets is at the contract execution date. This protects them from the price fluctuations, which is very common in the volatile crypto market. Future contracts are conducted on futures exchanges which act as the intermediary.
How does a Futures contract work?
A futures contract has two sides; long and short. If you go for the long, you agree to purchase an asset in the future at a fixed price when the contract expires. Whereas, for the short, you agree to sell an asset at a specific price when the contract expires.
Let’s say a poultry farm trades eggs for $2 a dozen. A local vendor expecting the price of eggs to surge enters into a four-month futures contract with the poultry farm for 1,000 dozens at the current price. Hence, the value of the contract is $2,000.
If in four months, when the contract ends, and the price of one dozen eggs is $3, the local vendor saves $1,000. The poultry farm will agree to the futures contract to maintain a stable sale of eggs, despite price surge. In the same way, it’ll protect them in case the price unexpectedly plummets.
What are Bitcoin Futures?
Bitcoin futures are based on the price of Bitcoin. No surprise there. With Bitcoin Futures, speculators can bet on what they think the value of Bitcoin would be in the future, and more importantly, it allows investors to speculate on the price of Bitcoin without needing to own any Bitcoin.
This has two main outcomes. First, despite Bitcoin being unregulated, Bitcoin futures can be traded on regulated exchanges. This eliminates worry for those who are anxious about the lack of regulation surrounding the crypto market. Second, investors in countries where Bitcoin is forbidden can still speculate on the price of Bitcoin.
How do Bitcoin Futures work?
Bitcoin futures are based on the same concept as the futures and conventional financial assets. In this system, based on their prediction about the price of Bitcoin, speculators either go long or short on a Bitcoin futures contract.
Consider this: Samuel owns one Bitcoin which is worth $16,000 and expects a price drop in the future, so to protect himself, he can sell a Bitcoin futures contract at the current price, $16,000. Come to the settlement date the value of Bitcoin and the Bitcoin futures contract would have dropped, allowing Samuel to buy back the Bitcoin futures.
If the contract is valued around $14,000 near the settlement day, Samuel has profited $2,000 and as a result, protected his investment by selling high and buying low.
In a nutshell, this is how a Bitcoin futures contract works. However, the terms of each futures contract may vary based on the exchange including the minimum and maximum price limits.
How to Invest in Bitcoin Futures
There are two different ways to invest in Bitcoin Futures. The first one is on cryptocurrency exchanges such as Binance , BitMEX , Kraken , and Coinbase . Although cryptocurrency exchanges have been offering Bitcoin Futures trading for a long time now, it mostly is unregulated. The second option is through exchanges that are publicly regulated. Chicago Board Options Exchange ( CBOE ) was the first to launch Bitcoin futures on its platform followed by the Chicago Mercantile Exchange ( CME ).
Similar to stock trading, Bitcoin trading is generally carried out through matching buy and sell orders. These orders are registered in an order book which is an electronic list of buy and sell orders for a particular asset. Once the transaction is complete the order is removed from the list.
What do Bitcoin futures mean for the Bitcoin price?
In the short-term, due to an increase in activity and overall interest, the value of Bitcoin goes up. The day following the launch of Bitcoin futures on the Chicago Board Options Exchange (CBOE), the price increased by almost 10% to $16,936.
Following the launch of Bitcoin futures on one of the top exchanges, CME, the value of Bitcoin skyrocketed, reaching the $20,000 mark.
It is difficult to forecast the long-term price of Bitcoin. However, it is very likely that it will keep on making good progress. Here, are a few reasons
Why Is it likely that the price will go up?
People will gain more confidence in Bitcoin futures as they get regulated on public exchanges. It eliminates worry and skepticism and gives people more assurance about investing in the crypto market.
As Bitcoin futures get widely accepted, they would be offered by institutional investors as a profitable investment option for their clients. This creates more liquidity in the market and trading cryptocurrencies becomes easier and more profitable.
Consequently, the Bitcoin market will expand and be available to a greater number of investors. Proper regulation will make Bitcoin trading possible in countries where it is currently banned.
Bitcoin Futures as an antidote
It has been well established that Bitcoin futures are a great way to protect yourself from the uncertainty of the crypto market. They help stabilize the price fluctuations of the underlying assets. Volatility has been the biggest setback poisoning the crypto market and Bitcoin Futures comes as an antidote against it. While assessing the investment opportunities, it is best to be cautious and understand the concept in and out to stay on the profitable side of things.