Though crypto exchanges have been offering them for years, Bitcoin futures arrived on publicly regulated exchanges in December 2017. In this guide, we explain what Bitcoin (BTC) futures are, how they work and why they’re controversial.
Bitcoin Futures, Explained
To understand how cryptocurrency contracts, it helps to first understand how they work in finance.
So let’s start simple. Futures are bets. They’re bets on the market price of a particular asset, letting two parties exchange, i.e. buy and sell, an asset at a specific price at an agreed-upon date. No matter what the actual market price is when the contract executes, the parties must buy/sell at the previously agreed-upon price.
Futures have been around for more than a century, and they’re largely the purview of professional investors and firms. But Bitcoin futures are relatively new, and so far, mostly traded by retail investors.
How Cryptocurrency Futures Work
Bitcoin futures (and those for all cryptocurrencies) work the same way as other futures: Parties make bets based on Bitcoin price analysis—will it go up or down? If you make the right bet, you profit in cash. If you don’t, you pay the victors.
But despite the “gambling” nature of these contracts, they’re not ideal profit maximization tools. Somewhat paradoxically, they can help balance a portfolio against risk and volatility.
While many met the arrival of Bitcoin futures with excitement, others speculate that their introduction has depressed the cryptocurrency market and will continue to do so.
The Benefits of Bitcoin Futures
If you can answer, what is Bitcoin, you probably know that Bitcoin isn’t ‘backed’ by anything. This means that the perception of risk is much higher.
Bitcoin futures provide investors with several benefits. And these benefits all relate to shielding investors from risk and volatility in the market. As such, one of the main benefits of Bitcoin futures for investors is that they allow people who don’t (or can’t) trade cryptos to speculate on them as an asset.
- Cash settlement. Because contracts pay out in cash, not more crypto, they give investors a way to profit on the market without directly touching the asset.
- Risk management. They reduce the potential risk of holding cryptocurrencies directly. Crypto investing is already a “bet.” Some think of futures as a way to hedge those bets.
- Portfolio stabilization. When an investment portfolio is built around an underlying asset with price volatility, like cryptocurrency, these contracts can help deflect some of that volatility, balancing the portfolio’s performance.
- Industry regulation. Now that Bitcoin futures are available on public and regulated exchanges, they are more attractive to institutional investors.
- Market stimulation. Because these contracts have the perception of being less risky, many expect them to attract more participation as Wall Street takes on Bitcoin.
How Cryptocurrency Futures Work: the Long and Short of It
Now that you understand what futures are and why they’re beneficial, let’s look at how they actually work. Remember, they’re essentially bets. And there are really only two types of bets you can make: short bets and long bets. If you’re new to investing, going long or going short is cryptocurrency slang you need to know.
When you go short, or “short” a Bitcoin futures market, you bet that the market for an asset will decrease in value. And you agree to sell at the previously agreed-upon price. A good example of this is the shorting that led to the 2008 financial crash. Ironically, Bitcoin was the final movement to come out of the financial crash.
A Bitcoin short position works the same way. When you go short, you bet the Bitcoin price will go down. If the price is lower when the contract executes, you win by selling Bitcoin at a price much higher than market value.
Going long is the opposite of going short. You bet that the price of Bitcoin will be higher when the futures contract executes. And you agree to buy the asset at the previously-set price. If Bitcoin price increases, you win by buying Bitcoin at a price lower than its current market value, gaining the difference.
Additionally, as prices rise and the value of your contract rises, you can also sell it to other investors at a higher price before it executes.
The key thing to remember is that on the contract execution date, both parties have to buy and sell at the previously agreed-upon price, irrespective of what the actual market price is.
Where to Invest in Bitcoin Futures
You can invest in Bitcoin futures both on cryptocurrency exchanges and on regulated industry exchanges. Retail investors, still Bitcoin contracts’ primary purchasers, can buy them through their broker if their broker participates.
Right now, however, choices are limited. The Chicago Board Options Exchange (CBOE) was the first to launch Bitcoin futures in December 2017. The Chicago Mercantile Exchange (CME) Group followed shortly thereafter.
TD Ameritrade is testing the waters, taking a conservative approach: Futures aren’t yet available to all clients. Alternatively, investors can purchase Bitcoin futures on cryptocurrency exchanges like BitMEX and OKCoin.