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EducationalAugust 27, 2020

All You Need To Know About Crypto Futures

Shubham Goyal
Product Specialist
August 27, 2020

Cryptocurrencies are evolving at phenomenal speeds. The industry has now moved forward from transactions and trading Bitcoin and other cryptocurrencies. Popular financial instruments that were a part of other trading spheres are now commonplace in the crypto world. One such financial instrument is a future or a futures contract, and it’s now an essential instrument if you’re looking to trade crypto seriously.

Futures Trading Basics

A Future is a type of a derivatives contract. Now, what are derivative contracts? Glad you asked.

Derivative contracts derive their value from an underlying financial asset – like gold, equity, crude oil, cryptocurrencies, etc. A futures contract is an agreement to buy or sell an asset or security at a later date for a pre-agreed price. Here both the buyer and seller are under an obligation to trade the underlying asset:

  • The buyer must buy the underlying asset on the date of the expiry of the contract.
  • And likewise, the seller has to sell the underlying asset at the said date at the predetermined price.

Why would they do this? Well, the buyer thinks that the price of the asset will be higher later, so it makes sense to purchase at a lower pre-agreed price. Correspondingly, the seller has a negative outlook on the asset and believes it would be prudent to sell at a price that is likely to be higher than one in the future.

Here the seller is called short and makes a profit if the price of the underlying asset decreases. On the flip side, the buyer, also known as long, makes a profit if the price of the underlying asset has increased. Another key point to note is that the terms ‘futures’ and ‘futures contract’ hold the same meaning, and are commonly used interchangeably.

Over time, futures have become a highly popular traded contract. A futures market is typically a trading exchange where these derivative contracts are bought and sold. Owing to this, they are generally referred to as futures exchanges. Exchanges like Delta are increasingly traders’ preferred choices for futures trading for Bitcoin and other cryptocurrencies.

How do Crypto Futures Work?

Let’s take the example of Bitcoin. In the case of Bitcoin futures, the underlying commodity of the futures contract is Bitcoin. Bitcoin futures work on the same principles of mainstream future contracts. Here the buyer and seller speculate on the price of Bitcoin and ‘bet’ on their own speculation of Bitcoin’s price in the future.

Bitcoin futures do not require an individual to actually own bitcoin. The individuals can just make a bet based on their own predictions. This eliminates the requirement of cryptocurrency wallets.

Sticking to the same example of Bitcoin, let’s attempt to understand a typical Bitcoin futures trade.

Suppose, a Bitcoin unit is priced at $11,000. You expect the price to rise by the end of a certain time period. Therefore you take a long position and buy Bitcoin futures for 1 Bitcoin. When the Bitcoin price goes up, you can sell the Bitcoin futures contract for a profit.

Similarly, if you expect that Bitcoin price will decline, you can take a short position and sell Bitcoin futures at the present market price. Now, when the price drops, you can sell your Bitcoin futures for a profit.

How do I Trade A Crypto Futures Contract?

You can buy or sell crypto futures contracts on cryptocurrency derivatives exchanges. All derivatives exchanges allow trading Bitcoin futures and typically charge a small fee for their services. Which exchange you pick then, is a function of the value of services you receive for such fees, and which other cryptocurrencies they may have listed.

Another place where you can trade crypto futures is through publicly regulated exchanges. While cryptocurrencies are, in many regions, unregulated assets, such exchanges may work under their regulators.

The Benefits of Trading Cryptocurrency Futures

Cryptocurrency futures come with a lot of benefits:

  1. Cryptocurrencies are a highly volatile asset. Their price can be soaring high someday and tanking the other. While such extreme situations are rare, the price does fluctuate more than typical assets. Futures hedging is a popular trading strategy. Crypto futures are therefore looked upon as an excellent hedging instrument that balances out any price fluctuations.
  2. Since they are futures, should you want to hold on to them, the price of the underlying asset – for example, Bitcoin – will remain fixed for you. This may be ideal for individuals having their core enterprise around Bitcoin, who can enjoy a stabilized price, irrespective of market conditions.
  3. While risk management is a, generating lucrative profits is undoubtedly another crucial facet of crypto futures. The seller hopes for a decline in price, to safeguard his investment. On the other hand, the buyer seeks a higher market price to make a profit on his Bitcoin futures.
  4. Crypto futures necessarily do not require you to buy the cryptocurrency. For example, you can directly purchase a Bitcoin futures contract without the need for a Bitcoin wallet. This comes as a relief to those who want to make profits on the price fluctuations of cryptocurrencies, or to individuals living in countries where owning and trading cryptocurrencies is shrouded in legal challenges.
  5. In particular, futures for popular cryptocurrencies, such as Bitcoin futures, are highly liquid contracts, at least on the best crypto exchanges. Traders who prefer high liquidity (who doesn’t?) will find much to like about Bitcoin futures.

What is the ‘Future’ of Crypto Futures?

There are some concerns regarding cryptocurrency futures, no doubt. Since they are often traded using margin or leverage, they become a higher risk instrument in an already relatively high-risk asset class. Exchanges offering crypto futures also tend to put price limits across futures contracts. This can cut into the trader’s profits.

But all in all. Crypto futures, Bitcoin futures and other popular derivative contracts (like options) have opened the gates for other popular financial instruments from conventional capital markets, to make their way in the cryptocurrency world. This has had a welcoming impact on the popularity and adoption of Bitcoin and other cryptocurrencies worldwide. If you’re looking to get started trading Bitcoin futures, sign up on Delta Exchange here.

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