Cryptocurrencies have undoubtedly come a long way from when they were an obscure and difficult-to-understand innovation.
As with other legacy financial markets like stocks, commodities, and currencies, we have seen different ways of trading this instrument aside from buying coins through an exchange.
One of these is the use of futures. The Chicago Board Options Exchange (CBOE) is credited as the first to provide futures on a cryptocurrency (Bitcoin) in December 2017.
The Chicago Mercantile Exchange (CME), the largest futures exchange on the planet, followed suit in the same month. While the CBOE has discontinued crypto futures, the CME still provides them, along with others like Eurex and ICE Futures US.
Of course, traditional crypto trading platforms like Binance, Kraken, OKX, and Bybit have long offered futures on several cryptocurrencies like Bitcoin, Ethereum, XRP, Litecoin, etc.
Futures are sometimes misunderstood by most investors. However, this type of trading is not very different from the traditional methods. Historically, futures have always been used for hedging positions.
However, over the last few years, futures have been traded for speculative purposes as well.
Firstly, what are futures?
A future or a futures contract is an agreement between two parties to trade specific financial security at a pre-specified price at a future date. Futures are another type of derivative, meaning their price is derived from an underlying asset (in this case, the price of a cryptocurrency).
The concept of futures trading has existed for several centuries. Their purpose has historically been to mitigate the price fluctuation risk of a financial instrument in situations where you expect a future-dated payment, whether in a foreign currency, a commodity like corn, grain, gold, etc.
We can broadly refer to this practice as hedging. Of course, futures have been applied to nearly all financial assets using most of the same concepts. One component is the expiration date, where the exchange or broker settles the futures contract.
This is almost always electronically in cash rather than the physical delivery of the underlying asset. However, this doesn’t necessarily apply to cryptocurrencies since they are naturally digital.
Therefore, you may receive settlement in US dollars or any other cryptocurrency. Another common trait is that most futures are settled well before expiration. Traders have the flexibility to end the contracts much sooner.
We’ll now dive into the inner workings of futures within the context of cryptocurrencies.
The inner workings of futures in cryptocurrencies
Let’s explore the main components of a cryptocurrency future.
Like most derivatives, crypto futures involve the use of leverage. With modern crypto exchanges, this can range from 2x or 1:2 up to 200x or 1:200. Moreover, traders are typically required to set aside money to maintain at least two margin balances (sometimes three with conventional futures exchanges):
- Initial (how much that’s required to open a position based on the maximum leverage provided)
- Maintenance (how much that’s required to cover any unforeseeable losses or avoid a margin call; more like a ‘backup fund’)
Any futures contract will have an expiry date, which will vary primarily based on where it’s traded.
In many cases, these expire after three months, as is traditionally the case with many futures exchanges. Most crypto exchanges apply the guidelines of those administered by the CME.
As mentioned earlier, a trader can settle the contract well before expiration. A futures product that’s becoming popular with crypto exchanges is perpetual swaps (or ‘perps’ for short), where the contracts don’t have an expiry date.
However, such derivatives come with funding rates after a set number of hours. We could simply think of this as a small fee you may receive or be debited for the exchange to ‘roll over’ your position into the next contract (since perps run continuously).
The price differences for any futures product have conventionally been measured in ticks, referring to the slightest change in price, typically to the right of the decimal. For example, if the price of Bitcoin increased from $38 000.00 to $38 000.50, this would be 50 ticks.
Each tick will be worth a set number of dollars. Moreover, different exchanges may have increments in ticks or points and value them accordingly.
If you’re trading futures through a marketplace like Binance or Kraken, there are no closing times (except for system maintenance periods).
However, if you’re using a conventional futures exchange, you’d be limited to a 24/5-like schedule that doesn’t permit weekend trading.
The advantages of cryptocurrency futures
The benefits of trading futures on cryptocurrencies will vary depending on whether you’re using a futures or crypto exchange. Principally, futures trading has been perceived as the most transparent because it occurs through a centralized exchange.
This quality allows all participants access to volume data in real-time. Such information can be useful for volume traders or those interested in order flow strategies.
While crypto exchanges have a similar structure (through order books), futures exchanges are considered superior because they are adequately regulated. The other benefit is how investors can use these derivatives to hedge their positions in the spot market.
For instance, one might buy Bitcoin through simple spot trading. To counter or hedge this position, they may proceed to sell BTC in a futures contract. Implementing this technique could provide the investor with an opportunity to profit regardless of the price direction.
Another advantage worth pointing out is most CFD brokers don’t offer much leverage with cryptocurrencies compared to instruments like indices and forex.
However, there are several crypto exchanges where you can receive above-average leverage, increasing your profit potential (but, of course, equally magnifying your potential losses).
Over the last few years, crypto-related futures trading has become a popular feature among crypto exchanges. We generally see more retail traders using these platforms due to their accessibility in capital and user-friendliness, higher leverage, and other innovative products.
On the flipside, futures exchanges like the CME and ICE have generally been reserved for larger so-called institutional investors who prefer them for their stringent regulation, substantial trading volume, and higher entry barriers.
Regardless, crypto futures share some similarities with ordinary spot trading, differing in a few ways here and there. As with any leveraged derivative, traders should be pretty knowledgeable about this instrument and understand all the risks involved.