Bitcoin Futures: A Smart Investment Move?

Bitcoin futures are a type of derivative contract that allows investors to speculate on the future price of Bitcoin without owning the cryptocurrency itself. These contracts are agreements between two parties to buy or sell Bitcoin at a predetermined price on a specific future date. The Chicago Mercantile Exchange (CME) and the Chicago Board Options Exchange (CBOE) are popular platforms for trading Bitcoin futures. While Bitcoin futures offer the potential for amplified gains through leverage, they also come with significant risks due to the volatile nature of the cryptocurrency market. Investors considering Bitcoin futures should carefully weigh the risks and benefits, including the potential for fraud or manipulation in the underlying Bitcoin market.

How do Bitcoin futures work?

Bitcoin futures are financial instruments that allow investors to buy or sell Bitcoin on a future date for a predetermined price. They are traded on a futures exchange, with the Chicago Mercantile Exchange (CME) and Chicago Board Options Exchange (CBOE) being the main regulated exchanges.

There are two positions you can take on a futures contract: long or short. If you take a long position, you agree to buy Bitcoin in the future at a specific price when the contract expires. If you take a short position, you agree to sell Bitcoin at a set price when the contract expires. For example, an investor who owns one Bitcoin, priced at $18,000, and foresees that the price will drop in the future, can protect themselves by selling a Bitcoin futures contract at the current price. If the contract trades for $16,000 close to the future settlement date, the investor has made $2,000 and protected their investment by selling high and buying low.

Another way to trade Bitcoin futures is through hedging. Hedging is a way to reduce risk, which is useful when dealing with the volatility of cryptocurrencies. For example, a trader who buys three Bitcoins at $60,000 each, believing the price will rise by the end of the month, can protect their position by entering a futures contract to sell one Bitcoin for $60,000 at the end of the month. If the price of Bitcoin goes up, they will make a profit by selling the remaining two Bitcoins. If it goes down, their losses will be limited as they can still sell one Bitcoin for $60,000.

When entering a futures contract, there are three ways a trader can exit their position: offsetting, rollovers, and expiry. Offsetting is the most common method, where a trader creates another futures contract with an equal value and size, making their effective obligations zero as they balance out. Rolling over is done by offsetting a position but with an expiry date that is further in the future. Expiry is when a contract reaches its end date, and the parties who hold the contract buy or sell at the agreed price.

Bitcoin futures can be beneficial as they provide opportunities for arbitrage, bring additional liquidity to the market, and allow investors to speculate on the price of Bitcoin without actually owning any. However, it is important to note that Bitcoin is a highly volatile and risky asset, and there is a possibility of losing significant amounts of money when trading futures.

Pros and cons of investing in Bitcoin futures

Pros of investing in Bitcoin futures:

• They offer a regulated way to gain exposure to cryptocurrencies, which is significant given the volatility of the ecosystem and wild price swings.
• They simplify the process of investing in Bitcoin. You don't need to create a Bitcoin wallet or put money into custody solutions for storage and security while trading because there is no Bitcoin exchange.
• They are safer than owning crypto. Bitcoin futures contracts have positions and price limits that enable investors to curtail their risk exposure to the asset class.
• They can be useful for both short- and long-term investors. Short-term traders may use Bitcoin futures to catch outsized gains during short spurts of increased volatility, while long-term investors may benefit from using Bitcoin futures contracts for speculative purposes or hedging.
• They can provide investors with flexibility, leverage, and the potential to mitigate risk via hedging.

Cons of investing in Bitcoin futures:

• Leverage can be a double-edged sword, and futures trading losses can add up quickly if the market takes a bad turn.
• Bitcoin futures traders are subject to margin calls that can trigger forced liquidation of their positions if they cannot maintain minimum margin requirements in their accounts.
• Bitcoin futures traders are also subject to exchange fees, which can affect trading profits.
• Bitcoin futures can be highly speculative. The high level of leverage means that investors can end up with an oversized position that ends up being worth very little or nothing.
• Exposure to the extreme price volatility in the cryptocurrency markets is one of the significant disadvantages of Bitcoin futures. Bitcoin and its ETFs can experience sharp price fluctuations in a short amount of time, which may disturb investors who are not used to such volatility.

How to trade Bitcoin futures

Trading in Bitcoin futures involves buying and selling Bitcoin futures contracts, where you speculate on the future price of BTC. Each contract represents 5 BTC, and they are traded on the Chicago Mercantile Exchange (CME).

To trade Bitcoin futures, follow these steps:

• Do your research to understand how Bitcoin futures trading works.
• Create an account with a registered futures commission merchant or introducing broker. You will need approval to start futures trading.
• Choose your preferred Bitcoin futures product, such as CME's standard or micro Bitcoin futures.
• Create a trading plan and manage your risk.
• Open your futures position and monitor it.
• Close your position before the contract expires if desired.

Some benefits of trading Bitcoin futures include:

• No need to worry about losing your private key.
• Use of limit and stop-loss orders to mitigate potential losses.
• Regulation by the CFTC.
• Ability to take a long or short position.
• Low fees.

However, there are also risks to consider, such as high volatility and the potential for significant financial losses. Additionally, Bitcoin futures are leveraged products, meaning you could lose more than your initial investment.

Risks of Bitcoin futures trading

Bitcoin futures trading is a highly speculative investment. The price of Bitcoin is extremely volatile, and its brief history has been marked by wild spikes and crashes. This volatility is further exacerbated by the fact that Bitcoin is a stateless digital currency and an unregulated entity.

Price Limits

Price limits imposed by exchanges, such as the 20% limit imposed by the Chicago Mercantile Exchange (CME), can cut into trading profits. This is because the reference price for Bitcoin derivatives is based on exchanges in unregulated markets, where price swings of greater than 20% are common. As a result, traders may not benefit from large spikes in Bitcoin prices.

Systemic Risk

The volatile nature of Bitcoin could pose a systemic risk to exchanges. CME's price limits could prolong a decline through the domino effect of futures traders selling their contracts en masse, potentially crashing the entire market.

Unstable Exchanges

Bitcoin exchanges, which provide a reference price for the asset, mostly work in unregulated markets and are therefore subject to manipulation. These exchanges have also experienced frequent outages during periods of high volatility, which could prolong trader losses and cut into their profits.

Timing

The introduction of Bitcoin futures trading could increase volatility, especially given the recent surge in Bitcoin's price. The increased speculation and number of new players in the market could lead to even bigger and more common wild swings in Bitcoin's price.

Leverage

The inherent leverage in the Bitcoin futures market can be a double-edged sword. While it offers the potential for large returns on small upfront investments, it also means that investors can end up with oversized positions that are worth very little or nothing if the market takes a bad turn.

Margin Calls

Bitcoin futures traders are subject to margin calls, which can trigger forced liquidation of their positions if they cannot maintain minimum margin requirements.

Exchange Fees

Exchange fees can also affect trading profits.

Lack of Regulation

The lack of regulation in the Bitcoin market leaves it open to potential fraud or manipulation.

Difference in Investment Outcome

A rise in Bitcoin prices may not result in a similar increase in the value of a fund holding positions in Bitcoin futures contracts. This is because funds that trade commodity futures contracts may not have direct exposure to the underlying assets, and futures contract prices can vary by delivery month and differ from the underlying commodity's spot price.

Exchanges that offer Bitcoin futures trading

Cryptocurrency futures are contracts between two investors who bet on a cryptocurrency's future price, giving them exposure to cryptocurrencies without purchasing them. Crypto futures allow investors to speculate on the future price of cryptocurrencies.

• Binance: The world's biggest cryptocurrency exchange by trading volume, Binance accounted for $60.30 billion of the total trading volume in Bitcoin perpetuals and futures on May 28, 2024. Binance has a position limit adjustment feature that enables manual reconfiguration of limits based on past trading history and margin amounts.
• Deepcoin: An innovative exchange that first joined the top three of the CoinGecko list in 2023. It had a trading volume of $8.26 billion on May 28, 2024.
• ByBit: While it may not be as well-known as Binance to US audiences, ByBit ranks among the world's biggest cryptocurrency exchanges. It had a trading volume of $21.40 billion on May 28, 2024. ByBit is not available to US customers due to regulatory compliance reasons.
• OKX: OKX offers 588 trading pairs in perpetuals and futures. It had a trading volume of $26.94 billion on May 28, 2024.
• Bitget: Established initially as a derivatives exchange, Bitget features 280 cryptocurrency pairs for trade, including perpetuals and futures. It had a trading volume of $19.51 billion on May 28, 2024.

Other exchanges that offer Bitcoin futures trading include the Chicago Mercantile Exchange (CME) and the Chicago Board Options Exchange (CBOE). CME Bitcoin futures contracts are traded on the Globex electronic trading platform and are settled in cash. The first Bitcoin futures contracts were listed on the CBOE in December 2017 but have since been discontinued.

Frequently asked questions