What is Bitcoin futures?
In early August, Atlanta-based Intercontinental Exchange (ICE), the world’s second-largest exchange and the firm that owns the New York Stock Exchange (NYSE), declared that it would be launching deliverable bitcoin futures, to be listed on the ICE Futures U.S. derivatives exchange.
ICE’s move toward making bitcoin futures is important and follows similar measures by the Chicago Mercantile Exchange (CME Group) and the Chicago Board Options Exchange (CBOE), two major derivatives markets which made bitcoin futures available in December 2017.
But what is bitcoin futures and what makes it significant for the future of the cryptocurrencies industry?
A short primer on futures contracts and trade
Futures were originally created to establish stability and manage risk. A futures contract is an agreement to buy or sell an asset at a future date at a predefined price. When two parties enter a futures contract, they will continue to exchange goods at the agreed-upon price regardless of any changes to its value in the markets.
Futures contracts usually involve a specific amount of a commodity, a predefined price and an expiration date.
For instance, a wheat farmer sells a futures contract to a baker to sell 500 bushels of wheat at current prices for the next year. If the price of wheat drops due to abundance, the futures contract will protect the farmer from losses. If the price of wheat rises due to bad harvest and low supplies, the baker will avoid paying higher prices. Overall, the futures contract protects both parties, called hedgers, from price fluctuations and brings stability to their business.
But aside from people whose businesses rely on commodities, there are other people who seek to benefit from futures contracts. These are investors and speculators who seek to make money off price changes in the commodity underlying a futures contract. They buy futures contracts because they believe it will be worth more in the future and can sell it to someone else at a higher price.
For instance, if an investor buys the aforementioned wheat futures contract and the price of wheat rises, the value of the contract will rise too, and the investor will be able to sell it to someone else.
What are bitcoin futures?
Commodities account for a huge part of the futures trading. But you can also find futures shares of exchange traded funds (ETFs), individual stocks and bonds, and even currencies. It is a very lucrative and attractive market for investors and speculators.
More recently, some of the biggest futures markets have also added bitcoin to their listing of financial assets.
Bitcoin futures work just like any other asset. For instance, if you currently have 3 bitcoins at the prices of $8,000 and you foresee that the price will drop in the next six months, you can sell a futures contract for 3 bitcoins at $8,000. If in the next six months, the price of bitcoin drops to $6,000, you would have prevented a $6,000 loss. On the other hand, if you’re estimation turns out to be false and the price of bitcoin rises by $2,000, you will have lost the same amount.
Why makes bitcoin futures significant for the cryptocurrency market?
First, the mere fact that some of the longest standing and well-established financial markets list bitcoin and enable the trading of its futures goes a long way to build trust in digital currencies. Shortly after CBOE made bitcoin futures available, the price of bitcoin spiked by almost 10 percent.
However, bitcoin futures have other advantages as well. While bitcoin is acknowledged as a revolutionary payment method, many avoid it because of its heavy price fluctuations. Bitcoin futures will help bring stability to markets that want to use bitcoin for payments and not necessarily speculation.
One of the important characteristics of engaging in futures trading is that it enables investment and speculation on assets without actually owning them. With bitcoin futures, investors and speculators can "wager" on its future value without actually holding any bitcoins.
This is important for countries where bitcoin trading is banned because it will enable investors to speculate on the price of bitcoin without running afoul of the law.
Also, while bitcoin exchanges are still largely unregulated, bitcoin futures are available on regulated exchanges. For those who are worried about the lack of regulation in the industry, bitcoin futures are a viable alternative to becoming directly engaged in cryptocurrencies.
Bitcoin futures are also more liquid because they’re dealt in cash, and their transaction speeds are much faster than the Bitcoin network.
What are the caveats?
Before engaging in bitcoin futures, you need to educate yourself on the dynamics of the futures markets and understand some of the fundamental topics that determine risks and returns such as leverage, volatility and time to expiration. For instance, if a futures contracts runs its course, you have to settle the difference, whether it’s a gain or a loss.
Also, since bitcoin futures don’t give you actual bitcoins, you won’t benefit from the free coins that are made available to bitcoin holders when the currency undergoes a hard fork such as last year’s Bitcoin Cash hard fork.
Where can you trade bitcoin futures?
Since late last year, CBOE and CME Group made bitcoin futures available. These are two heavily regulated and long-established exchanges, which makes them safe places to invest in futures contracts.
TD Ameritrade has made CBOE bitcoin futures available to its clients as well. Goldman Sachs has also expressed interest in trading bitcoin futures contracts very soon.
Some cryptocurrency exchanges such as BitMEX, OKCoin and CoinfloorEX also offer bitcoin futures trading.