Futures is a financial instrument that belongs to the derivatives category, that was initially invented to provide protection (or hedging) to investors from price fluctuations of assets.
Futures give the ability to buy or sell an asset on a specific future date, at a specific price. While futures were introduced as a risk management tool, soon became a very popular speculative method over the moving price of an asset.
By taking short or long positions, investors can benefit if the price of the underlying asset moves in their favor and, conversely, experience loses if the price goes against them. However, it is very rare that a futures contract reaches its expiration date, as investors are free to close the contract whenever they want. Futures is a leveraged financial product, which means that an investor can open a position that is much bigger than his actual capital. This means that a commodity’s futures reflect physical amounts that are much higher than the actually available commodity, hence futures contracts are mostly settled in cash (e.g. Gold’s futures market is ten times higher than the actual resources in gold).
How Does Futures Trading work?
Let’s say that today the price of corn is $2000 per ton. A supermarket chain expects that the price of corn will increase to $3000 per ton in the next 3 months. By purchasing a 3-month futures contract (long position) agrees to buy 10 tons of corn after three months at today’s price. If in fact, after three months the price of corn will reach $3000, the supermarket will have saved $10000. On the other hand, if the market moves to the other direction (let’s assume that the price drops at $1000 for ease of reference), the supermarket will experience $10000 worth of losses.
How Does Bitcoin Futures Work?
Bitcoin futures are no different than other assets. Investors are given the ability to speculate on the price of Bitcoin, without actually having to own them. Bitcoin futures trading was launched by regulated exchanges like the CME and CBOE in December 2017, removing the uncertainty of the cryptocurrencies’ unregulated environment. Additionally, investors from countries that have banned the controversial cryptocurrency (e.g., Bolivia, Ecuador) can now invest on Bitcoin and profit by its volatility, in a legal manner, while receiving the benefits of this regulated financial instrument. It is important to note that, the same as most futures contracts, Bitcoin futures settle in cash. Investing in Bitcoin futures at a regulated exchange, will not require you to install a wallet, as you would be paid in fiat money.
However, some investors faced issues with cash-settled Bitcoin futures. As they are not directly tied to Bitcoin, they cannot offer hedging abilities and are mostly used for speculation. Coinfloor, a UK based cryptocurrency exchange, will be the first to offer physically-settled Bitcoin futures in April 2018.
Bitcoin’s price swings allure more investors; therefore, the advent of Bitcoin futures trading can only have a positive side-effect on the Bitcoin itself. For example, Bitcoin’s price surged by 10% on the first day of Bitcoin futures trading was launched on CBOE. Furthermore, being traded in reputable and regulated derivative exchanges, Bitcoin will gain credibility that will result in higher liquidity, making transactions easier to validate in the Blockchain. Similarly, popular coins like Ethereum or Ripple may be positively affected by Bitcoin’s public acceptance, that will enable them to enter regulated markets in the future.
However, there is also a group of Bitcoin’s proponents that seem to be worried, claiming that by these developments will prevent potential Bitcoin buyers in the future, as they will prefer to speculate on its price on a risk-free environment. Most importantly, major financial institutions (opposed to Bitcoin) could manipulate Bitcoin’s market, by taking massive short positions on Bitcoin’s futures, forcing its price to a free fall.