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The introduction of Bitcoin Futures to the financial sector has had some significant effects on the market. These unique financial instruments enable savvy investors to leverage Bitcoin's volatility without actually holding any Bitcoin. This scenario is ideal for large scale investment firms and those seeking to avoid investing in unregulated markets, such as cryptocurrencies.
Primarily, Bitcoin Futures function similar to stock or commodities futures. Simply put, a Future is a legal agreement to trade a commodity at a predetermined price and date. In this way, Futures allow investors to speculate on the future price of any given commodity. Consequently, Futures play a critical role in the financial sector.
For example, imagine a gold mining firm and how it might utilize futures to its benefit. The miner continues to unearth precious metals as inventors seek to secure their holdings at the current prices. As the product doesn’t exist yet, there are still price fluctuations that could hinder or boost profits. To buffer the risk involved in this investment, the miner may decide to agree to sell their precious metals at a predetermined price and date.
In this way, they can ensure they receive their minimum required ROI. Reversely, an investor would seek to acquire a futures contract for less than what they predict the market value of gold will be at that time. Consequently, this maneuver provides more room for profits on the back end. The difference between the price of the future and the actual price of the commodity at the time of the sale is the investor's profit.
Risks with Bitcoin Futures
It's important to mention that futures are not foolproof investments. The scenario could occur where the price drops and the investor is stuck with a future that is over-priced. This is the situation that occurred shortly after the launch of Bitcoin Futures in late 2017.
As the latter example shows, it takes an experienced investor to leverage futures properly. Critically, you will need to have a firm understanding of the market cycles and fluctuations if you intend to make a profit trading futures. That being said, there are some undeniable benefits Bitcoin Futures introduce to the sector.
Benefits of Bitcoin Futures
In the case of Bitcoin Futures, the advantages are too great to ignore. For one, Bitcoin Futures trade on regulated exchanges. Currently, you can access Bitcoin Futures on some of the most reputable exchanges in the US including CME, Bakkt, and CBOE. Importantly, these platforms receive regulation directly from the Commodity Futures Trading Commission.
Regulated exchanges are more secure than their crypto alternatives. In the past, investors incurred major losses after the collapse of unregulated crypto exchanges. In one now-infamous instance, the largest crypto exchange at the time, Mt.Gox, collapsed after a hack left the exchange in financial ruins. Sadly, the collapsed exchange cost investors millions. Worst of all, investors had no recourse because the platform was unregulated.
Another major advantage of Bitcoin Futures is that they settle in cash. This makes sense once you realize that no actual Bitcoin trading occurred. In fact, the investor and the exchange never own any Bitcoin during the transaction. Rather, an agreement to trade Bitcoin in the future at a set price trades. This strategy means that Bitcoin Futures investors don't need to own a Bitcoin wallet or any other crypto-supportive software to participate.
Another advantage Bitcoin Futures bring to the market is the ability to short. Shorting is an investment strategy where an investor enters into a trade with the goal to profit from a drop in the market value of an underlying asset. Because Futures pricing updates daily, investors can short futures by repurchasing their contract at a lower price.
Keenly, you can continue to repurchase your futures contract at a lower and lower price as the market drops. In this way, investors can see huge profits during times of market losses. However, it's also important to mention that large scale shorting puts negative pressure on the market value of an asset.
- Bitcoin Futures via CME
One of the most attractive attributes about trading futures is that you only need to put a percentage of the contracts total down to trade. This percentage, known as the margin, ranges from 10-20%. Importantly, this strategy allows investors to leverage their position to maximize profits. In essence, investors gain unlimited profit potential. Reversely, there is unlimited loss potential as well.
Notably, it took years before Bitcoin Futures appeared on US regulated exchanges. Specifically, in December 2017, both the Chicago Board Options Exchange (Cboe) and the Chicago Mercantile Exchange (CME) introduced Bitcoin Futures. Notably, the issuance of these futures provided a boost to Bitcoin's market value. Specifically, Bitcoin rose by 10% on news of the succesful launches.
The issuance of a third Bitcoin Futures contract by CME helped catapult Bitcoin to its all-time high of just over $20,000. However, the excitement was short-lived. The following year saw the cryptomarkets enter into a year-long bear market that saw Bitcoin's price drop from over $20,000 down to just over $3,000.
While many speculated the price drop was due to scalability issues within the Bitcoin network, the Federal Reserve Bank of San Francisco suggested that Bitcoin futures were one of the main contributors to the drop. The reasoning behind this allegation is the introduction of shorts to the market.
Bitcoin Futures – Issues to Address
Bitcoin Futures are set to play a critical role in the market moving forward. As such, they continue to be at the forefront of any cryptocurrency discussion. Specifically, non-profit clearing houses have voiced concerns over market manipulation in the past. Despite these concerns, you should expect to see even more Bitcoin Futures entering the market in the coming months.