Before we dive into what bitcoin futures really is, let’s start with what do we really mean by a futures contract. A future’s contract is an agreement between two parties to buy or sell an asset on a specific future date at a specific price. Once entered into a futures contract, both of the parties have to buy and sell at the agreed upon price on the agreed upon date, irrespective of the actual price at the contract expiry date. The goal of a futures contract need not be profit maximisation, it’s also a risk management tool. Futures contracts are negotiated and traded on a futures exchange. The futures exchange acts as the intermediary.
So how does a futures contract work? With a futures contract, one can either go long or go short.
Going long means that you agree to buy an asset at the specified price in the future when the contract expires. On the contrary, going short is related to selling the asset at the set price when the contract expires.
To understand how the futures contract work, let’s take the example of oil traders. Suppose an oil trading company enters into a futures contract foreseeing that price of oil might up go up. Now two things can happen. The price can go up or it can go down. Suppose that price goes up. In that case, the buyer will benefit as they won’t have to buy at the elevated prices. The seller will be benefited as well because, for him, a steady supply is ensured. In the case where the opposite happens, i.e the price goes down, the contract will protect them.
However, not everyone is interested in staying with the contract till the end. There are investors who just buy and sell. That is they go long when the price is low. And as the price rises, the contract becomes more valuable. Now, obviously, people will be interested in buying the commodity at a lower price than at a higher one. So they buy that contract from the above-mentioned investor before the expiry. This way, both the parties benefit.
That was all about what a future contract really is. Now a futures contract is not only for physical assets, it can be for financial assets as well. Bitcoin futures being one such example. Bitcoin futures is a contract based on bitcoin’s price in future. With Bitcoin futures, speculators can place a bet on bitcoin’s price in future. Investors can speculate what they believe will be the price of bitcoin in future without even owning a bitcoin. It is well known that bitcoin is largely unregulated. This prevented a lot of investors to invest in it. The launch of Bitcoin futures has however been a good news for them because Bitcoin futures will be traded on regulated exchanges.
A futures contract will also benefit investors. To understand how to assume that the current price of bitcoin is $20,000 and an investor owns a bitcoin. He foresees that the price is going to drop in future. So he sells a futures contract at the current price i.e $20,000. Now close to the settlement date, since the price of bitcoin will have dropped, therefore the contract will become less valuable. This will cause the price of the contract to drop. The investor can again buy the contract, this time at a lower price. So, he sold it for higher and bought it for lower, thus making a profit.
Recently, Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange(CME) introduced a futures contract for bitcoin, with the former being the earlier one to do so. But what will be the effect of such a decision? An obvious effect almost everybody has noticed is the sharp increase in the price of Bitcoin as well as other cryptocurrencies. Looking at the stats, we see that a day after bitcoin futures was launched on CBOE, the price of bitcoin jumped by almost 10%. Similarly, when CME followed the lead, the price shot up and crossed the $20,000 barrier. Another effect of the recent launch is that institutional investors are more likely to offer Bitcoin futures to their clients as a viable investment option. Introduction of Bitcoin futures also brings more liquidity to the market. And as the ripple effect goes, it is possible that altcoins might also become tradable as futures in future.
Another thing that an investor needs to know is where to trade Bitcoin futures. One can choose to trade on unregulated exchanges or he can go for regulated ones. Talking about the regulated ones, we have exchanges like Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange(CME). Besides, TD Ameritrade and JP Morgan have also expressed their interest to allow access to these markets. On the other hand, unregulated exchanges are older than the regulated ones. Cryptocurrency exchanges like Bitmex and Okcoin can be used for trading a bitcoin futures contract.
Will Bitcoin futures be successful? Only time can tell. But it’s good to see that it has brought bitcoin to the masses to some extent. Prices will likely drop after rising a lot but that’s because the currency would have overshot its value and a drop will cause a correction. If we think about it, that’s what happened with gold as well in the 1970s. And we all know where gold stands today. Should we say more?