You’ve probably heard more than once about cryptocurrency futures contracts. This type of transaction is very popular nowadays, but not everyone knows what exactly it is. Let’s get to the root of the matter and learn about its terms.
What are cryptocurrency futures and how do they work?
Crypto futures are an agreement to either buy or sell an asset at a certain price in the future. By entering into the contract, it represents an element of protection for companies and the industry against possible future price changes. Once an agreement is made, the parties are obligated to abide by its terms, regardless of the market price at the time the futures contract expires.
The underlying asset may be cryptocurrencies, commodities, bonds, indices, interest rates and other assets.
Futures contracts are so named for a specific reason. Because, unlike stocks or currencies, you can’t buy them and just let them go. Each contract, like futures, has a start date and an end date. There are several such contracts: trading cannot be stopped during the year, and the investor can pass to the next contract after the contract has been executed.
Expiration is the fulfillment of the contract, when the final settlement between the parties of the transaction is made. Simply speaking, it is the final stage of the futures life, and then the next contract with a different execution date is traded.
Let’s say 1 coin costs $100, and you decide to buy 10 futures contracts on it, and you spend $200 on it, for about two months, which means you’ve bought a commitment where you can buy 10 coins at the market price. And let’s say your expectations are met, and the price goes up to $200, and you transfer the contracts to another market participant. Making a profit of $200.
However, if two months have passed since you bought the futures, your contracts will automatically close at the market price. The bad news is that the difference between the strike price and the closing price is deducted from your collateral. In other words, you could lose an amount of $200. But the good news is that you will not lose more than the amount you invested in securing the trade. Of course, this is just an example of small numbers which in practice will be much higher.
Some futures contracts also offer leverage, a strategy in which traders borrow capital to fund contracts. Leverage is a special service in which additional cash or securities are provided to the investor so that the customer can open a position. Simply put, leverage allows you to open bigger positions with no need for pre-funding.
What are the different types of futures?
There are two types of futures: delivery and settlement.
In a delivery contract, one sells on a certain date (delivery date) and another buys a certain quantity of specific goods. Settlement is based on the price quoted on the last trading day. If the seller fails to deliver the goods by the delivery date, the exchange issues a penalty.
A settlement contract is a futures contract in which the commodity is not delivered and the settlement is based solely on the difference between the current and future prices of the futures contract.
Therefore, the essence of such a futures contract is that upon expiration the asset is not delivered, but the variation margin of the futures contract is calculated. This margin is calculated by the exchange using a special formula and paid to the contract holder on a daily basis. It can be compared to the accumulated coupon on a bond. Thus, the futures remain liquid, because otherwise they would be traded only on the issue date and maturity date.
Where to buy cryptocurrency futures?
There are several options for trading cryptocurrency futures, which depend on what you need. There is an option to trade futures on American platforms, but it is worth considering that they are strictly regulated by law. As one of the variants, you can use the services of crypto exchanges, for example WhiteBIT trade crypto futures. WhiteBIT offers trading in USDT(S) Bitcoin futures at the moment. The USDT(S)-M futures contract with unlimited maturity means that USDT is a settlement currency and there is a possibility to use leverage.
To buy a futures contract on WhiteBIT, follow these steps:
- select the “Futures” section in the top right corner of the exchange menu;
- open the “Buy BTC” tab;
- choose the order type, the amount of BTC you wish to buy and the leverage;
- click on “Buy”.
Perform the same procedure to sell a futures contract, but in the Sell BTC tab. The funding rate and countdown to its accrual can be found in the upper right corner.
Such exchanges feature much less demanding identity verification procedures and AML policy requirements. Additionally, such platforms have a much lower entry threshold, which means that they are not only available to large investors. The advantage of using cryptocurrency futures exchange is that it offers more than just Bitcoin contracts. It gives users more flexibility and allows for more sophisticated strategies. One of the other advantages is that you can start with a lot less money than if you choose one of the corporate offerings. So you don’t have to necessarily be a rich trader who already has room to open an account with them. So, this confirms the notion that cryptocurrencies provide financial resources to everyone, not just to the wealthy.
What are the pros and cons of trading futures?
There are many advantages that explain the high volume of trading business:
- Low entry threshold. To buy futures, all you have to do is pay a margin fee, which is usually 10-20% of the price of the entire contract. And even with this relatively small amount you can make money.
- High liquidity. Trading volumes on futures contracts are higher than on cryptocurrencies. However, not for all contracts.
- You have access to more different assets, including the commodities market. This allows you to diversify your portfolio and make money on different assets.
- Standardization. All futures are standardized, investors do not need to agree on contract specifications or even prices: everything is already there, you just need to choose the right option.
- Hedging. When you own a cryptocurrency, to protect yourself from its fall, you can open a short position on futures at the same time. Regardless of the price trend, the fall of the currency will be counterbalanced by the profit on the corresponding contract.
As for the disadvantages, the following should be noted:
- High volatility. It complicates the analysis of the market situation and increases the possible losses.
- High risk of big losses for inexperienced traders. In most cases beginners trade with big leverage which leads to losses. Sometimes they don’t understand how leverage works and they quickly go into red. Before you start trading, you must understand what is margin trading, margin call, leverage and position security. If you don’t understand these aspects, you can easily zero out your account right at the start.
What effect do futures have on the price of Bitcoin and cryptocurrency in general?
With the appearance of the first Bitcoin futures, different opinions have emerged among market experts about the possibility of their influence on the price of the currency itself. Classic market investors believe that the appearance of futures on the asset reduces the volatility of the underlying asset and that Bitcoin futures give “free hand” to large market participants, allowing them to bet on the fall of the currency, which causes it to actually fall.
In addition, many experts believe that the appearance of Bitcoin futures in the traditional market will contribute to the widespread popularity of cryptocurrencies. Hence, the demand and positive impact on the price and market capitalization in perspective can be boosted this way.
Conclusion
In summary, a futures contract is a forward contract that binds whoever enters into it. Of course, each trader must decide whether this area of finance is in his or her best interest. For some, the advantages may not outweigh the disadvantages, and some prefer to own the asset rather than have a contract tied to the asset. The decision is up to you. But before you plunge headfirst into the world of trading, research as much information as you can, weigh all the risks, and make decisions only with a cool head.