Although cryptocurrencies have existed for over a decade, their prominence has arguably only taken off in the last five years or so. Since Bitcoin’s seminal introduction in 2009, this financial instrument has taken the world by storm, for better and for worse.
As with any asset class, we have many ways of trading it. In the context of profiting from trading a coin, you don’t need to own the underlying asset, and this is where futures come in.
Futures trading in cryptocurrency was first introduced in December 2017 at the height of the bull market that year. Nowadays, you can trade this particular market on numerous traditional marketplaces like the Chicago Mercantile Exchange (CME) and Eurex.
Crypto trading platforms like FTX, OKX, and Binance have also joined the fray by providing futures with experimental versions through perpetual swaps, higher margins, and 24/7 trading.
This article will explore the notional value of futures in crypto, which will help investors acknowledge how such instruments are priced, and the effects of leverage.
For reference and simplicity purposes, all the illustrations we’ll cover here will be largely based on the trading provided by the CME, as it’s the largest exchange for this security globally.
However, much of the concepts will apply to some extent to other exchanges or brokers.
Firstly, what are the cryptocurrencies’ futures?
Understanding notional value means first grasping what a future in cryptocurrencies is. A future or futures contract is a type of derivative where two parties trade a coin at a predetermined price at a future date.
The purpose of any futures market has historically been to hedge against price fluctuation risk in scenarios where the trader expects a future-dated payment. Nowadays, people use this security to speculate for profit, as in the ordinary spot markets.
However, futures offered by crypto exchanges provide higher leverage than in spot, making them highly attractive for speculators. As with any derivative, its price will be based on an underlying asset which, in this case, would be that of a digital currency like Bitcoin (BTC) or Ethereum (ETH).
Notional value in cryptocurrency futures
Although any derivative is meant to track the cost of the asset closely it’s based on; the two amounts are never precisely the same based on numerous exchange-determined factors, most notably leverage or margin; this is where notional value comes into the picture.
Notional value in crypto futures simply describes valuing a position through a particular index or reference rate, which varies widely in different exchanges. Such a mechanism distinguishes the total value of the potential trade from the market value.
For instance, if the market value of a cryptocurrency is $5000, the notional value (depending on the exchange) can allow the investor to control the coin’s price with far less than $5000 in their account.
We get the notional value by taking the contract unit size multiplied by the contract price (don’t worry, we’ll dive deeper into this one).
To better explain this concept, we’ll use the BRR (Bitcoin Reference Rate), a daily-updated reference rate used by the CME for Bitcoin derived from numerous spot exchanges.
Presently, the BRR is $40,043.36 (essentially the contract price), which is more or less the value of BTC. Calculating the notional value of a Bitcoin future also requires the contract unit.
With the CME, a BTC contract is five times the value (the contract unit) of the BRR. Therefore, the notional value is $200 216.8 (5 X $40043.36). However, one wouldn’t need to put the entire $200 216.8 to enter into the contract due to leverage.
Presently, the margin requirement with the CME is 50% (or 2x max. leverage), meaning the investor would need half the notional value ($100 108.4) to take a position.
Fortunately, the CME offers micro futures on Bitcoin and Ethereum, where the minimum contract size is 1/50 of the standard contract, which is far more affordable for the average investor.
The presence of leverage
Leverage is a staple in virtually all derivatives trading as it allows traders to amplify their buying/selling power using far less capital. You can gain substantially more profits through margin than simply buying a particular cryptocurrency without it.
With crypto trading platforms like Binance and FTX, the leverage on such an instrument is generally higher than the spot market. For example, if the price of a coin was $10 000 and you had 1:100 or 100x leverage, this means that you can control the same value with only $100 in your account.
However, the cliched adage of leverage being a double-edged sword remains true as any slight price change can quickly wipe you out.
This is particularly important to note as futures are measured in ticks (denoting the minimum price fluctuation or increments), which, like the notional value, will be different for each exchange or broker.
For instance, the ticks for CME’s Bitcoin futures are quoted in multiples of $5. Since a BTC contract is five times the value of the BRR, one tick for this market is worth $25.
Curtain thoughts
Centralized exchanges like the CME are seen as the traditionalist and safest way to trade crypto futures as they are regulated and offer transparency through real-time volume data. Yet, you can gain more benefits from the crypto exchanges we mentioned, such as Binance and the like.
Crypto decentralization allows for greater leverage and, unlike conventional exchanges with limited business hours, 24/7 trading. Moreover, innovative products like perpetual swaps (futures with no expiry date) can be provided to clients.
Regardless of where you trade this market, you should grasp different values like the notional value. Many traders can overlook position sizing in any traded market, which can be a huge mistake considering real money is always on the line.
