As speculation of regulatory guidelines and institutional investment in cryptocurrencies continues to unfold, keeping up with all of the developments can be challenging.
However, Bitcoin futures have been available since the end of 2017, and they are increasingly available on regulated exchanges. They also may potentially impact regulatory decisions on further financial instruments for Bitcoin, such as ETFs.
For investors looking to speculate on the price of Bitcoin without having to actually own any directly, Bitcoin futures provide a viable, regulated means to do so effectively. Further, futures can help hedge against risk against the volatile price fluctuations of Bitcoin.
What Are Futures Contracts?
Financial futures are contracts that specify the buying or selling of an underlying asset at a predetermined price on a precise date in the future. Counterparties are obligated to fulfill the terms of the contract upon expiration, either buying or selling the asset at the price once the contract expires.
Parties can take two positions in a futures contract; long or short. Long means that the party agrees to buy the underlying asset in the future at a specific price, while short means the party agrees to sell the underlying asset at a specific price upon the contract’s expiration in the future.
Futures contracts are traded on regulated exchanges and are regulated by the Commodity Futures Trading Commission (CFTC). They are regularly used for two purposes:
- Speculating on the price movement of the underlying asset.
- Hedging risk.
In the first case, a party can purchase a futures contract on a commodity — such as oil — if they anticipate that the price of oil will rise leading up to the expiration date of the contract. For instance, if oil is $50 a barrel at the time of contract’s initiation and the buying party expects the price to rise before the expiration of the contract, they can profit off of the price difference — if the asset increases in price — through cash settlement, or can sell the contract on the spot market later at a higher price.
So, if party A buys a futures contract for two barrels of oil at $50 per barrel, and by the time of the contract’s expiration the price rises to $80 per barrel, then party A can make a profit of $60 from the $30 price difference per barrel. Futures are not limited to commodities, however. They can be used as a tool for the speculation on the price of financial assets as well.
In the second case, futures contracts are used as a hedge against adverse price movements that would affect an entity that actively uses or produces the underlying asset in the contract. In this way, a party can ensure more stable financial results from their business at the current price rather than suffering losses from adverse price movements.
For instance, if the current oil price is $50 per barrel, a shipping company that expects the price of oil to rise can buy a futures contract for 10 barrels at $50 per barrel. Their contract would then be worth $500. Upon the expiration of the contract, if the price of a barrel of oil rose to $60, then the company saved $100, providing a useful mechanism for reducing their exposure to the price movements of oil.
Futures contracts often lead to a less volatile price of the underlying asset in the long-term, especially if the futures market for the asset is highly liquid.
What Are Bitcoin Futures?
Bitcoin futures are futures contracts that speculate on the price of Bitcoin without participants actually having to own Bitcoin. Upcoming futures trading platforms like Bakkt offer physical delivery of the underlying asset for contracts, but it still remains within their custody rather than the purchasing party having to directly buy and sell Bitcoin on cryptocurrency exchanges and store it in their own wallet.
Entities that participate in Bitcoin futures are essentially making a bet on the price of Bitcoin over a specified period. Bitcoin futures work the same way as any futures contract on a traditional financial asset. Investors can either go long on Bitcoin — expecting the price to increase — or short it, mitigating potential losses if they actually own some Bitcoin.
For instance, if Bob owns 10 Bitcoin at $5,000 and expects the price of Bitcoin to drop, he can sell (short) a futures contract at the current price of $5,000.
If the price drops to $4,000 near the expiration of the contract, then he can buy (long) back the futures, meaning that he protected $10,000 on his investment by selling his contract at a higher price than when he bought at $4,000.
Bitcoin futures provide several advantages for investors.
- First, they are traded on regulated exchanges, making the process much more familiar and comfortable for mainstream and institutional investors who may not want to deal directly with cryptocurrency exchanges.
- Second, the contracts allow for speculation on the underlying price of the asset without having to go through the process of properly storing bitcoins, which is a high barrier to entry for many people unfamiliar with how Bitcoin works.
- Third, by granting Bitcoin more exposure to investors, more liquidity is added to the market. Finally, futures trading can lead to less volatility of Bitcoin’s price in the long-term and enable investors to protect themselves from adverse price swings.
Institutions are also more likely to offer Bitcoin futures trading to their clients since it is within a regulated exchange and reduces the risks associated with holding bitcoins.
Platforms Offering Bitcoin Futures Trading
CBOE — one of the largest futures trading platforms in the world — launched the first Bitcoin futures in December 2017, followed by another Chicago-based platform, CME. Since then, several platforms and major institutions have signaled their plans to launch Bitcoin futures, including some cryptocurrency exchanges. Some of the major platforms where you can trade Bitcoin futures include:
- CBOE – One of the largest futures exchanges in the world. First to launch Bitcoin futures trading.
- Chicago Mercantile Exchange Group (CME) – Chicago-based derivatives and futures trading exchange. Recently announced that Bitcoin futures trading grew 119 percent throughout 2018 on their platform.
- BitMEX – One of the largest cryptocurrency exchanges. Offers Bitcoin futures trading (not available to U.S. citizens).
- TD Ameritrade – One of the largest brokerage firms in the world. Recently launched Bitcoin futures trading.
- OKEx – Hong Kong-based cryptocurrency trading platform offering Bitcoin futures — not available to U.S. citizens.
- Nasdaq – Second largest stock market exchange (by market cap) in the world. Planning on launching Bitcoin futures trading in early 2019.
- Bakkt – Upcoming Bitcoin futures trading and custody platform backed by the Intercontinental Exchange (ICE) which owns the NYSE. Have delayed the launch several times, but plan on offering physical delivery of Bitcoin for futures contracts in early 2019 and provides custodial services for investors.
Bitcoin Futures’ Role in Further Regulatory Progression
Bitcoin futures were the first major institutional development concerning the offering of Bitcoin trading within regulated exchanges. Since then, numerous developments have unfolded regarding Bitcoin’s status as an asset as well as the potential offering of Bitcoin ETFs.
In particular, the SEC has denied several applications for Bitcoin ETFs already, citing that Bitcoin futures markets are not mature or liquid enough to support Bitcoin ETFs. Moreover, the SEC recently postponed a decision on one of the leading ETF proposals — from VanEck & SolidX — until February.
Bitcoin futures trading offers several advantages to investors and should continue to grow as Bitcoin’s legitimacy as a financial asset garners more support by both regulators and investors. Several platforms are already offering futures trading for the legacy cryptocurrency, and the launch of Bakkt is seen as a significant step forward for Bitcoin futures trading among institutional investors.