What are Bitcoin Futures?
What are Bitcoin Futures?
Definition of futures
Futures are known as “futures contracts”. This is a real contract, a firm commitment of standardized delivery, whose characteristics are known in advance, on:
a defined amount of an underlying asset,
at a time, and a given place,
and traded on an organized futures market.
How futures work.
The principle is that two parties agree in advance on a price, however the payment and delivery of the property, subject of the contract, are made at a later date (hence the term futures contract). Futures can relate to any type of goods: commodities, raw materials, agricultural products, currencies, Bitcoin. It can also relate to a stock index. The contract may either provide for a physical delivery of the goods or a financial settlement equivalent to the difference between the price fixed by the contract and the price of the goods on the markets on the day of delivery.
Futures contracts represent at least 40% of the global volume of financial markets. Since the 1970s, it has been the main markets for medium and long-term interest rates.
Futures market: an organized market!
The Futures category is the most widely traded financial instrument in the world. They are traded only on markets that are official and regulated (example: Matif, Liffe, CBOT, Eurex …).
The clearing house is a key player in the Futures market.
The latter, as soon as a transaction is registered, replaces the counterparty and the seller and the buyer. Thus, when an operator X buys a contract from an operator Y, the transaction is divided: Y buys from the clearing house, Z sells to that same room. The clearing house then takes the counterparty risk instead of the participants. For this, each member pays a room deposit to the room at the execution of each negotiation.
These security deposits are revalued daily according to the market value of the positions held by the participant.
Note that buyers and sellers can always “unbuckle” their position by buying / selling the same amount of contracts originally sold / bought, which in this case will disappear their position.
Contract maturity and potential gain on Futures.
At maturity, the contracts are liquidated according to the specifications established at the beginning, or the seller actually delivers the underlying by, or pays in cash at the market price, the sellers paying the value reached by the contracts on the day from the liquidation, to the buyers.
The strategy of the traders is to make gains by betting on the evolution of the prices: if they foresee a fall of the prices, then they sell contracts to realize thus a capital gain by then buying them less expensive when the deadline approaches . On the contrary, if they expect a rise in prices, they buy contracts that they will resell more expensive later.
In any case, and as recalled by the Financial Markets Authority:
“Past performance is no guarantee of future performance.”
and the Futures market exhibits the same volatility as other financial markets.
wheat: Let’s take the example of a future for a ton of wheat. If we think that the price of wheat will rise, rather than buying a ton of wheat, it is easier to buy a future. One then agrees to buy a ton of wheat later at the current rate. If, on the contrary, someone thinks that the price of wheat will fall, then he will sell that future.
Suppose we buy this future, it has a duration of three months and it covers 50 tons of wheat at 200 Dollars per ton, or 10 000 Dollars. Three months later, the ton of wheat is 20% more expensive, or 240 Dollars. Two issues are then possible:
If the contract provides for a physical delivery, then the buyer actually receives 50 tons of wheat, which he pays 10,000 Dollars on the agreed date. As on the day of delivery, these 50 tons are worth 12 000 Dollars, the buyer is a good deal. The seller must respect his commitment, even if it is disadvantageous for him.
If the contract provides for a financial settlement, then there is no delivery, but the buyer receives at the agreed date 2 000 Dollars from the seller, which corresponds to the gain. Again, the seller can not shirk.
If we now consider the case where the price of wheat fell by 20% over the three months:
In the case of a physical delivery, the transaction happens in the same way, at the same price and on the same date. This time the seller makes a good deal, since he sells more expensive than the price of wheat on the day of delivery.
In the case of a financial settlement, this time the seller receives 2,000 Dollarss from the buyer.
Things can get a bit complicated, as there is no requirement for the buyer and the seller to hold a future until maturity. The buyer or seller may respectively sell or redeem the contract to someone else, and transfer to him the obligations of the contract. The sale or redemption price of a future is based on the price of wheat at the time of sale.
Are producers and buyers the only actors involved in buying and selling futures?
Obviously no! Those interested in future contracts are not only actors with a regular activity and wishing to stabilize the amount of their payment each month. Indeed, future contracts are also very popular speculators. It is true that the very nature of the future contract with its date of execution and its fixed price lends itself very well to speculation and wagering.
Thus, to think about buying or selling a future contract can be seen as a direct bet on the future price of an asset. Continuing the previous example, imagine a future contract stipulating a price of $20,000, or $200 per ton (remember that a future contract is worth 100 tons). In concrete terms, a speculator convinced that the price will be less than $200 / ton on the day of the execution date takes a short position on the contract. This means he promises to sell 100 tonnes of wheat (which he does not necessarily own) at $20,000.
Note that the future contract itself is exchangeable until the execution date and the price of this contract fluctuates with the market price of the underlying asset. So, if the speculator has a hollow nose and the price of wheat (and therefore that of the future wheat contract) falls as you approach the expiration date, the speculator can simply buy back a another future contract, ie offsetting its original short position by a long equivalent position now that the contract price has fallen, thus “closing” its position while making a profit. For example, the day before the execution date, if the market price for the ton of wheat is $ 180, all he has to do is buy a future at $18,000 to make a profit of $2,000!
But then if one is a speculator, what is the difference between buying a future contract and buying an asset (or an action) directly?
For this type of exercise (speculation), it is easier to use a future contract. The contracts are standardized, and especially the use of margin (that is to say the use of the loan to magnify its position) is much simpler. Thus, technically by buying a future you very often pay only a fraction of the price of the underlying asset (20% is very common, the rest being the day of the expiration date) allowing to play on large volumes.
In addition, taking a short position is much simpler than with a traditional stock (for a variety of reasons including the fact that shorting a stock requires opening an account with a broker and keeping enough funds to support it. position which amplifies costs).
Is it legal for speculators to use this market?
Why is speculation simply not prohibited?
Speculators have a bad reputation in public opinion and are often perceived as parasites.
On the other hand, it is perfectly legal to speculate, including on commodities. Indeed, the market “needs” speculators to be fluid. Indeed, if it is easy to buy and sell a future, it is because there is an important supply and demand. Speculators are an integral part of this cycle and bring liquidity to the market that would be much drier without their presence (understand that it would be more complicated to trade and also more expensive).
Moreover, attempting to ban them would require an exact definition of a speculator within a specific market, which is speculative (more complex than it appears), as well as department to impose and manage these restrictions. Needless to say, all of this would be expensive and would be reflected directly in the transaction costs.
Finally, speculators play a certain role in the discovery of prices. Indeed, when the speculator places a bet with his money, believe me, his goal is not to lose! Thus, speculators place their “bets” knowingly and are often among the best informed players on the market. Therefore, a massive influx of speculators taking a short position surely indicates that an asset is overvalued (at least temporarily), and the pressure exerted on the price thus makes it possible to bring the asset back to its “true value”.
How does a future Bitcoin contract work?
Is its operation similar to that described for the commodities market?
The operation of a Bitcoin future is similar in all respects to that of convenience. Indeed, future contracts are not restricted to physical assets and are equally applicable to financial assets, which includes cryptocurrencies.
Where and how can I buy a future Bitcoin contract?
The futures for Bitcoin are tradable since last December in two public markets.
Bitcoin futures are available for trading on the Cboe Futures Exchange, LLC (CFE). CFE launched trading in Cboe bitcoin futures since December 10, 2017 under the ticker symbol “XBT”.
The Chicago Mercantile Exchange (CME) followed with its launch Dec. 17, 2017.
You can also buy and trade Bitcoin Futures on Bitmex.
Like any futures contract, trading in XBT futures is not suitable for all investors and involves the risk of loss. The risk of loss in XBT futures can be substantial. Market participants should, therefore, carefully consider whether such trading is suitable in light of their own circumstances and financial resources.
So, if Bitcoin Futures are just speculation on Bitcoin Price and settled in Dollars, it therefore does not really help with the real trading of the Bitcoin Asset itself as people just bet on prices but never buy or sell real Bitcoins…
Bakkt in 2019 might well change the Bitcoin Trading landscape as Bakkt will buy Bitcoin and not only offer price speculation on Bitcoin like Bitcoin Futures do!