What is Bitcoin Futures? Guide for Beginners

05/13/2022By: C, Fiona

For many years, Bitcoin trading has been the main solution for those who want to make profits without traditional rules. It is steadily subverting the traditional way of making money.However, what is Bitcoin futures? To understand what this means, let’s explore its investment field with a fine tooth comb.


What is Futures?

Futures is a standard contract between two parties, which purchases or sells specific assets at a specific time on a predetermined date in the future. Usually, futures contracts are traded on futures exchanges.

Futures agreements include the quality, quantity and price of underlying assets. There are many reasons for signing futures contracts. First, because it is a transaction agreed to be conducted at a specific price at a specific time in the future, the buyer of the underlying asset is protected from the price changes of the asset in the market. This may bring profits and sometimes losses to the contract holder because there is a commitment to buy or sell at a specified price.

Most contracts in the financial sector give the contract holder the “right” to do something. However, futures contracts introduce a different concept, providing contract holders (both parties) with “rights” and “obligations” to fulfill the details of futures contracts. Usually, some futures contracts require physical delivery of the assets involved, while others are in cash.But how does it work?

How do Futures Contracts Work?

Futures contracts involve both parties, namely the buyer and the seller; It allows them to lock in costs and trade before the assets are harvested.

Some assets, such as commodities, are used as futures contracts on futures exchanges. For better understanding, suppose a farmer wants to sell a lot of corn in the next harvest season. Although corn has not yet been produced, farmers want to ensure that they pay an appropriate price for corn in the future. Then, a buyer is looking for the next crop of corn, and he is willing to pay the current market price or similar price for it. In this case, the seller and the buyer can sign a futures contract at a specific price. This will protect sellers and buyers from price fluctuations.

Futures contracts usually have two main traders, usually called hedgers and speculators. Hedgers are interested in underlying assets. They try to offset the risk of price changes, while speculators have no practical use for assets linked to futures contracts. Instead, these people speculate, buy futures, and then sell them to interested people to make a profit.

In futures contracts, you can enter a long or short position.Long refers to a party’s commitment to buy assets on a specific date and time, while short refers to a party’s intention to sell assets on a specific date and price.

What is Bitcoin Futures?

According to the trading concept of conventional assets such as commodities and stocks, you can also trade Bitcoin futures.Simply put, Bitcoin futures involve both parties and a contract to buy or sell Bitcoin at a specific future price and date. At the end of 2017, CME Group launched Bitcoin futures contract. Contracts traded on Globex electronic trading platform are settled in cash. Bitcoin futures are based on CME CF Bitcoin reference exchange rate.

Trading Bitcoin futures does not involve actual Bitcoin. Futures are not settled in Bitcoin. Like other futures contracts, you predict the price of Bitcoin rather than buying or selling the relevant cryptocurrency assets themselves. However, if you expect Bitcoin prices to rise, you can take long positions; Or if you hold Bitcoin, take short positions to reduce the risk of possible loss.

It must be known that the price of Bitcoin futures contract is roughly proportional to the price of Bitcoin. Therefore, Bitcoin futures trading is an alternative to spot trading, which involves the actual purchase or sale of relevant cryptocurrencies.

Spot trading only provides you with basic trading instructions, such as buy low and sell high, and you often make a profit during market pumping. On the other hand, Bitcoin futures trading offers many benefits, including trading and leverage during bull and bear markets.

Types of Bitcoin Futures

Today, there are several types of Bitcoin futures markets, and different platforms provide different derivatives transactions. The most common products are standard futures contracts and permanent swap contracts. These two are popular derivatives that are usually traded in today’s investment field. However, the two have different characteristics. Before you put money on them, you must clearly understand them.

Futures Contracts and Permanent Swap Contracts

Conceptually, we emphasize the essential difference between Bitcoin permanent swap and Bitcoin futures contract, which we will explain in this way.

Bitcoin perpetual swap does not set an expiration date for the contract. It is basically infinite; There is no end. On the other hand, Bitcoin futures contracts have an agreed maturity date. Therefore, there is a period of fulfilling the agreement. This usually takes up to a month or more.

Since perpetual swaps have no maturity date, exchanges use a price synchronization system called the capital interest rate mechanism. This mechanism stabilizes short and long positions in permanent swaps by increasing or decreasing transactions. It is more like a fee that helps maintain short and long positions in permanent contracts.

Another notable feature of perpetual swaps is that they usually keep track of the spot market, which may be attractive to cryptocurrency traders. However, volatility is the main risk attached to this. Therefore, during the period of market fluctuation, the price of permanent swap contract often deviates from the spot price.

Similar to Bitcoin futures, there is a process of eliminating and re establishing long and short positions in perpetual swaps. This process ensures the convergence of permanent price and spot price through currency exchange between long and short traders. There is no need to keep the price synchronized with Bitcoin futures, because the terms of the contract and the assets involved will converge automatically with the emergence of the maturity date.

How Does Bitcoin Futures Work?

The working principle of Bitcoin futures is the same as that of typical futures contracts. In addition, there are centralized exchanges like binance that allow large-scale risk-taking.
In order to better understand this, suppose we buy Bitcoin with a futures contract of $40.000, which will be settled in two months.

Our futures contract obliges us to buy $40.000 Bitcoin within two months. If the price was $50.000, we would make a profit of $10.000 per share. However, if it has dropped to $30.000 by then, we still have to buy it at $40.000, and in fact we have lost $10.000 per position.

If we believe the price will fall, we can sell it under the same conditions with a futures contract of $40.000. This means that if Bitcoin falls to $30.000 on the maturity date, we can still sell it for $40.000 and make a profit of $10.000. Vice versa: Bitcoin should be higher than $40.000 on its maturity date.

In order to accept this obligation, we take out some money, which is called “deposit”. Margin is the minimum collateral you must have in your account to execute transactions. The more money you invest, the higher the margin the exchange needs to complete the transaction.

Generally, the margin is between 5% and 15% of the value of relevant assets, so we take 5% as an example. We pay $1000 x 40 000 dollars to buy a futures contract. The value of these positions will be $40 million, but we only took out 5% of the contract.

Leverage

The higher the leverage, the more vulnerable you are to high profits or losses. In addition, the amount you can trade depends on the amount of margin you can get. For example, binance provides leverage of about 125 times the transaction amount. Leverage determines the level of volatility in your trading.