All About Crypto Futures Explained l In-Depth Guide

A Brief Description of Crypto

Crypto futures, or Futures Contracts, is an agreement between two traders or investors that entails buying or selling a virtual currency at a given time in the future.

This method allows market participants to reduce the risk of anticipated price changes in the selected asset. Notably, futures contracts were initially applied in the transactions between merchants and farmers.

For instance, a farmer foresees in May that he will harvest a specified amount of corn by September. The farmer and merchant would agree on a future contract on how much the merchant would pay to deliver the predetermined amount of corn.

This futures-type contract would help the farmer and merchant to reduce their price risk as market fluctuations cannot affect the already-done deal. But besides protecting themselves against price risk, futures contracts enable traders and market participants to gain from speculations.

Understanding Futures Contracts

Futures contracts are also known as derivatives of an original asset, and they serve as financial instruments that get their value from the asset. These contracts primarily aid the transactions between two parties involved in commodities investment, allowing them to predict the asset’s future price.

The contract entails certain predefined parameters such as pricing procedures, quantity of units, methods for settling the contracts, and margin requirements. Importantly, all parties involved in the contract must adhere to these parameters.

Here are the contract details regarding Bitcoin futures offered by Chicago Mercantile Exchanges (CME):

Ether (ETH) futures’ contract details at CME:

How Futures Contracts Work on Regulated Exchanges?

Generally, regulated exchanges and trading venues are bound by government regulations that prescribe the maximum allowable leverage for futures trading.

That said, engaging in Bitcoin futures trading requires a 50% margin of the contract’s value, necessitating a $25,000 margin deposit. The remaining amount for the contract purchase can be funded through leverage.

Notably, the value of the contract is not static but fluctuates with the underlying asset, which in this case is Bitcoin. Also, CME relies on the Bitcoin Reference Rate, a daily calculation based on the volume-weighted average price of Bitcoin from various exchanges, conducted between 3:00 pm and 4:00 pm London time.

Depending on the price movements of Bitcoin, you have the flexibility to either hold onto your futures contracts or sell them to another party. When your contracts are completed, you can allow them to expire or roll them into new ones, collecting your owed cash settlement.

Furthermore, the steps involved in trading Bitcoin futures mirror those of trading regular futures contracts. It all starts with establishing an account with the brokerage or exchange of your choice. After your account gets approval, you’ll need permission from the trading service provider to initiate futures trading.

Generally, this second approval hinges on factors such as funding requirements and your experience in derivatives trading. These same factors also influence the determination of leverage and margin amounts for your trades.

How Futures Contracts Work on Unregulated Exchanges?

Unregulated cryptocurrency exchanges have their unique narrative when it comes to trading futures. They embrace a certain level of freedom that allows traders to engage in risk-taking activities that might be considered excessive elsewhere. 

Take, for instance, Binance’s approach when introducing futures trading on its platform in 2019. Initially, it offered an astounding leverage of up to 125 times the trading amount. However, this aggressive stance was later scaled back to 20 times the trading amount in July 2021.

Approaching this kind of trade requires understanding the connection between higher leverage ratios and increased trade volatility. So, while considering the benefit of substantial profits, it’s also vital to acknowledge the high-risk level of significant losses.

This particularly relates to your margin. In essence, the extent to which you can engage in trading futures hinges on the margin available in your account. This is because it serves as the minimum collateral required to execute trades.

So, as the size of your trade increases, the broker or exchange demands a proportionately higher margin amount to facilitate the transaction. For instance, Bitcoin futures may require a 50% margin, whereas Ether futures might necessitate a 60% margin on certain exchanges.

Interestingly, brokerages that offer futures products from various companies may impose their own margin requirements, which can be in addition to the base rates set by the exchange. 

Popular Platforms to Trade Futures Contracts

Data from CoinGecko as of October 3, 2023, reveals the top five Bitcoin futures trading platforms as given below:

1. Binance: Renowned as the world’s largest cryptocurrency exchange, Binance dominated the scene with 294 trading pairs and over $34.1 billion in trading volume for Bitcoin futures.
2. ByBit: Although not as familiar to U.S. users as Binance, ByBit held its ground among the giants of the crypto exchange world. It boasted a trading volume of $10.2 billion on October 3, 2023. However, ByBit isn’t accessible to U.S. customers due to regulatory compliance.
3. Deepcoin: Deepcoin was introduced in 2018, deals with derivatives, and features 81 trading pairs. In the meantime, it displays a 24-hour trading volume of over $10.6 billion, with a 24-hour open interest of over $4.4 billion.
4. OKX: OKX, another major player, boasted a wide array of 395 trading pairs in perpetual and futures. It reported a trading volume of $13.1 billion on October 3, 2023.
5. Bitget: Initially established as a derivatives exchange, Bitget offered a diverse range of 221 cryptocurrency pairs for trading, including perpetual and futures. The trading volume on the same day stood at $4.4 billion.

Benefits of Trading Futures Contracts

Market participants benefit from trading futures contracts, the key being their regulatory exposure. This is particularly true given the volatility of the ecosystem, resulting in high price swings.

Other benefits of this trading method include:

Risk Mitigation and Hedge

Long-term investors in the crypto arena can employ crypto futures as a hedge against downside risk. By assuming a contrary position in futures contracts compared to their crypto holdings, they diminish short-term downside risk and potentially earn profits using these contract instruments.

Versatility in Strategy

Crypto futures contracts grant traders a remarkable degree of strategic flexibility. For instance, traders can readily take short positions on assets if they anticipate a decline in their crypto’s value.

Such ease and simplicity in strategy execution are not typically found in spot or margin trading. This adaptability also enables traders to implement scalping strategies effectively, a less efficient approach in traditional spot markets.

Precision in Pricing

As seen in traditional futures contracts, crypto futures contracts are inherently perpetual, devoid of expiry dates. Consequently, these contracts closely mirror actual spot prices with minimal deviation.

While traditional futures may trade at premiums or discounts depending on market sentiment, perpetual crypto futures contracts adhere closely to spot prices, aided by the concept of funding rates.

Unlocking Financial Leverage

A key attraction of crypto futures lies in its utilization of financial leverage. This leverage allows traders to control a substantial contract value linked to an underlying asset with only a modest amount of capital.

Simple and User-friendly

Crypto futures trading stands out for its user-friendly approach. It simplifies the process of investing in cryptocurrency assets, speculating on their price movements, and reaping profits without owning and securely storing the actual crypto assets.

Emphasis on Security

Safety is a key aspect of the futures market, particularly for traders. As a benefit, crypto futures contracts come with well-defined positions and price boundaries, allowing traders to mitigate their risk exposure effectively.

Enhanced Profit Potential

The leverage concept in futures contracts gives traders the opportunity to increase their potential gains. This factor makes it particularly enticing for experienced traders in the crypto space.

What to Consider When Trading Crypto Futures?

The cryptocurrency futures landscape is witnessing significant growth in the number of platforms offering these trading options, along with a surge in the participation of traders and trading volumes.

Unlike more established commodities, cryptocurrency futures trading is still developing, which gives rise to its unique characteristics.

Trading Volume

Regarding trading volumes, cryptocurrency futures can often mirror the activity in the spot markets. Price fluctuations, particularly during periods of high volatility, can be significant.

During these turbulent times, cryptocurrency futures may closely track spot market prices or exhibit considerable deviations, trading at a premium or a discount compared to spot prices.

This implies that Bitcoin futures, for example, might not always provide adequate protection against the inherent volatility of the underlying futures market.

Regulatory Environment

 

Notably, only a few selected trading platforms operate under the supervision of regulators, leaving most of these platforms unregulated.

CME is among the few regulated platforms under the supervision of the Commodities Futures Trading Commission (CFTC). Meanwhile, the world’s largest crypto exchange, Binance, only possesses the United States subsidiaries. As a result, its offerings remain limited in the country.

Futures Contract Options

Cryptocurrency options have emerged as a relatively recent development in the financial landscape. It was in January 2020 that CME first introduced the trading of Bitcoin options, followed by Ether futures options in March 2022.

These cryptocurrency options operate like traditional options contracts, granting the holder the right, but not the obligation, to purchase cryptocurrency at a predetermined price.

In this context, the underlying asset comprises cryptocurrency futures contracts traded on the CME platform. Each options contract corresponds to a single futures contract, consisting of 5 BTC or 50 ETH.

Furthermore, CME offers options contracts for six consecutive months at any given time, with monthly expiration dates and two additional contract months in December.

Traders in this market could acquire call options if they anticipate a Bitcoin price rise. Conversely, a put option is a bearish wager on the decreasing cryptocurrency’s value. It’s important to note that the potential gains and losses differ in each scenario.

In the case of a call option, gains could be unlimited because Bitcoin’s price can increase indefinitely. However, losses are restricted to the premium paid for the contract.

On the other hand, losses can be unlimited for put options, as the price could plunge to zero. Meanwhile, gains are restricted to the premium paid for the options contract.

It’s worth highlighting that Bitcoin’s price volatility adds a significant element of risk to options trading in this space. The implied volatility of options contracts is notably high, translating to elevated prices for individual Bitcoin options. These elevated prices can amplify potential losses for traders.

Conclusion

Cryptocurrency futures are specialized contracts derived from the underlying cryptocurrency prices. They offer traders a means to engage with price movements without owning the cryptocurrencies physically.

This approach helps mitigate the risks associated with acquiring actual digital assets, as you are essentially trading on your predictions of their future price actions.

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