What are Bitcoin Futures?

Overview

Crytpo anticipation – strapping on your space suits, while reserving a portion of self for another crash. In constant moments of uncertainty, it seems there is nothing better to do than hypothesize. But hasn’t that become one of the hidden arts of our community? It’s true, we rode the high of all highs, watching Bitcoin sky to $20,000, convincing ourselves that our Blockfolio was bulletproof… followed by the most obvious next question: “I wonder if they make bulletproof yachts?” Telling everyone that we know, this is it, I’m on a game show and can’t lose. But then it happened, that thing that all the “financial experts” told us would happen, “the bubble popped” – “Bitcoin, the Biggest Bubble in History, Is Popping” as Bloomberg News put it.

Now, to all readers (including myself), I could spend the next ten minutes shilling the market and how this “bubble” was in fact no bubble whatsoever. I could show some comparative charts, with the most advantageous zoom percentage, align it to the dot com bubble and show the amount we have left to climb before we start calling cryptocurrency a bubble, but I’ll save that for a later article.

Regardless, there we were at rock bottom: unsociable, uninterested, (maybe even unemployed for those true believers), wondering how we’re going to pay rent – since our pride couldn’t possibly let us pull out of this love-hate market so quickly. So it begins with our community – when we sit at the lowest of lows, it’s time to hypothesize. “China New Year will bring the end to this slump”, “Everyone is just paying their taxes”, “Goldman Sachs is coming, that’s going to turn it around”, “Wait for the Illuminati”… whatever. Meanwhile, there slips in this massive occurrence during our most recent low point: December 18, 2017, “CME introduces BTC Futures”. Over the following months, our CryptoK9 team sat, wondering “how does this really change anything…” into worrying… “is this price suppression permanent?” Insert fear and internal FUD. Thus, we decided we would learn a bit more about this tool which filled the rumor mills.

Comparison of forward contracts to futures contracts

Now, there is a vital piece of information before we dive into the application of futures contracts to cryptocurrency – familiarization of terms. There is a plethora of terms in this realm of trading – but for now, let’s focus on the bigger picture – the difference between a forward contract and futures contract.

A forward contract is defined as a non-standardized agreement between two parties to buy/sell an asset at a future date, with the price being decided now.

While a futures contract is defined as a standardized contract, which is negotiated at the intermediary futures exchange, between two parties to buy/sell an asset at a future date, with the price being decided now.

The two biggest differences are obvious: 1) the futures contract contains standardized agreements and 2) these agreements are negotiated by the futures exchange. Essentially, with the futures contract exchange acting as an intermediary, buyers and sellers are interacting with the exchange, which all but eliminates the possibility of default by the other party – acting as a means of security.

Where did futures come from?

With the most basic understanding of futures contract, it seemed fitting to spend a bit of time learning of the inception of such an ingenious concept – and oddly the original futures contracts strike a peculiar resemblance to the futures tools we employ today.

The world’s first futures contracts, executed within a futures exchange – the Dojima Rice Exchange, were established in 1697 in Osaka, Japan. Why was a rice futures exchange necessary in Japan? During this time period, Japan’s feudal lords and samurai were paid in rice; thus, arose a need for an exchange, which could convert rice to cash – resulting in the establishment of the Dojima Rice Exchange.

With this exchange creation follows the familiar headlines we’ve grown accustomed to – manipulated price fluctuations, advantageous conversion rates…and it’s starting to sound like Wall Street – a market. As we know, with all markets comes an inevitable crash – the Dojima Rice Exchange was no exception. It fell victim to this infallible rule of markets in the early 1730s, and as a result, the people of Japan saw the price of rice plunge. With plunge – mass panic; perhaps even more so for the two aforementioned groups, as they realized their rice income – converted to cash – become a lot less valuable, seemingly overnight. Now comes market manipulation – the crash period was followed by mass speculation across the market, causing traders to fluctuate the price to a point of volatility beyond comprehension. This was followed by the price of rice being increased beyond the normal households’ ability to pay. Then the inevitable government interjection with regulation – and the story has the same mundane end as nearly all financial crises; however, the cool thing about this one – it produced the tool our community can now begin utilizing.

Now the application: What are BTC Futures and the utilization of BTC Futures contracts

BTC Futures are futures contracts that allows individuals to buy or sell BTC at a pre-determined price on a future date – through the utilization of a BTC Futures Exchange. These contracts will allow traders to bet on whether the price will rise or fall, without actually having to hold bitcoins.

Purchase

Intriguing, so how does one access BTC Futures contracts? Entering positions in these contracts acts similar to traditional futures contracts – through a broker. Currently, only a handful of brokers have enabled BTC Futures trading for private clients.

Strategies

Once the BTC Futures contract positions are entered, traders implement the strategy most aligning to their outlook on BTC prices. More terms that the CrytpoK9 team heard iteration after iteration, not realizing they were falling on deaf ears – “Long” and “Short”.

Long: these are positions that are meant to hold for a rising market – when bull? Essentially for long positions – a trader practices his/her strong hands – HODL, well kind of. The long position agrees to buy the position, at a specific price, when the contract expires. Traders bank on the idea that the market will continually rise over the next period of time – then at the end of this rising period, the contract expires and the trader purchases BTC at the specific contract price.

Short: these are positions entered with the intent of profiting from a falling market – why bear? For short positions – a trader decided to go weak hands for a profit. The short position agrees to sell the position, at a set price, when the contract expires. Traders bank on the idea that the market will continually fall over the next period of time – then at the end of this falling period, the contract expires and sells BTC at the specific contract price. The trader can then buy back a BTC Futures contract at a lower, more preferable price.

Now, these are the more notable methods which float around the crypto-sphere. Futures trading also allows traders to effectively hedge their positions through the utilization of another strategy – Spread Trading.

Spread Trading: this strategy combines a long and short position entered at the same time in related BTC Futures contracts. This idea allows the trader to effectively hedge uncertain markets, while profiting from the price difference between the two contracts. Essentially, the trader assumes the risk of the difference between the two contracts, instead of the risk of a single futures contract. There are several different types of spreads, including: Calendar Spreads, Intermarket Spreads, and Inter-Exchange Spreads.

Settlement

There are two popular methods in which to close a position in the futures market. Offsetting contracts through liquidation is the more popular, while the other method involves a cash settlement.

Liquidating: A liquidation – or offset – completes a futures transaction by bringing the trader’s net position back to zero. This method resulting in a “back to zero” state does not relate to profit or loss. Instead it means that if an investor has purchased a specific number of BTC Futures contracts, for delivery on a specific date, the investor must sell the same number of BTC Futures contracts for the same delivery date. Net profit or loss, after allowance for commission charges and other transaction costs, will be the difference between the premium paid to buy the contracts and the premium received when the contracts are liquidated.

Cash Settlement: In a cash settlement, traders make payments at the expiration of the contract to settle any gains or losses. Once the final settlement price is determined, traders with open positions close them by settling the gain or loss with cash.

What does this mean for the market?

Leverage: An important portion of futures trading rests with “margin trading”. A margin requirement is how much investors must set aside so that other parties in the trade know any losses can be covered. Think of it as a down payment on the investment. Why is this important? Leverage.

A typical margin can be anywhere from 10 to 20 percent of the price of the contract. Thus, an investor can leverage available cash to enter more contracts than using the cash to purchase BTC at current market price. However, due to the volatility of BTC, and the early stages of BTC Futures, futures exchanges are requiring a larger percentage of the contract price for margin requirement – traders of CBOE BTC Futures are required to have at least 44% of the bitcoin settlement price set aside for their bet. For now, the margin requirement is steep to participate in this type of trading; however, if the price of BTC is “tamed” – as CME group’s Leo Melamed predicts – then traders will begin to see the margin requirement decrease, allowing their funds more purchase power. With more purchase power, traders have the ability to buy more BTC Futures contracts – thus, resulting in more possibility of traveling to the moon (equal risk if the market acts opposite to the traders’ strategy).

Risk: BTC Futures offer more traditional investors a familiar path into the cryptocurrency market. The benefit to these types of investors is the risk reduction. With constant “Hackers Empty BTC Wallet” headlines filling the air around our community, risk reduction is a huge building stone in allowing the path for more funds into the market. Since BTC Futures contracts allows a way to enter the market, without purchasing actual BTC – the concerns of safe storage and security diminish. This should be an easy path for those investors interested in the gains of cryptocurrency but adverse to the such security risk.

FOMO Profitability: The factor that our CryptoK9 team thinks makes the BTC Futures creation most appealing is the ability to capitalize on big news surrounding BTC. There are constant adoption headlines and BTC $100k price predictions that could spark a large volume of investors to bet long and influence the price of BTC (then, hopefully the crypto market as a whole) north. But also, the technological piece – imagine if BTC Futures would have been in place during the Bitcoin Gold hard fork (the hard fork following Bitcoin Cash, where hodlers received free Bitcoin Cash). Speculation for the Bitcoin Gold hard fork drove the price of BTC to a new all-time high: on Oct. 20, 2017 – five days before the Bitcoin Gold fork – BTC surpassed $6,000 for the first time, eventually climbing to nearly $6,200. With BTC Futures, news surrounding adoption and technological potentials will be even more magnified in scope.

Overall, BTC Futures is a step for cryptocurrency to become a more complete market setting. The CryptoK9 team sees this as a huge opportunity for our market to become more approachable for larger investors, and potentially truly address some of the volatility concerns. Reduced volatility could bring more money to the overall market and help us early adopters become early retirees.

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