Bitcoin futures - what are they and what do they mean for the cryptocurrency?

11 December 2017
For the first time ever, Bitcoins are tradable on the Chicago Board Options Exchange (Cboe) in the form of futures contracts.

bitcoin on keyboard

This shapes up as a huge step towards legitimisation for Bitcoin which, like many cryptocurrencies, has notoriously been portrayed as a vehicle for illicit pursuits and purchases.

The news that Cboe would launch Bitcoin futures broke last week, with the exchange beating several similarly bitcoin-minded competitors to be first to offer investors a way to bet on (or against) the skyrocketing cryptocurrency.

Prior to the launch, Cboe revealed the following in regard to their Bitcoin futures:

  • Each contract is for one bitcoin
  • The minimum movement will be 0.01% (US$10)
  • Traders will be required to have 44% of the current daily settlement price on hand to cover any day-to-day losses on their trades.

The launch temporarily crashed the exchange’s website but the currency itself rallied significantly, with its value increasing by over US$1,000 in less than ten minutes.

While CME and Nasdaq Inc. (two of the US’s largest exchange companies) have flagged their plans to debut Bitcoin futures contracts in the near future, many brokers and financial entities were more apprehensive.

TD Ameritrade, a large online broker, said they would not provide the product for customers, and major American banks such as JPMorgan and Citigroup said they would not clear trades on the new product.

For those not in the loop, here’s what all the fuss (and worry for some) is about.

What is a futures contract?

Futures contracts, more colloquially referred to as futures, are legal agreements between two parties which lock in the purchase or sale of an asset at a fixed point in the future for a fixed value.

The point in time is  predetermined as is the purchase/sale price, which is taken from the current market price of the asset in question and then tweaked for things like carrying costs and the duration of the contract.

When compared against normal on-the-spot asset trading, a futures contract could be a more desirable option for those who aren’t ready to or don’t want to trade their assets just yet, but know they will trade them at some point in the future. The asset holder may also think the value of said assets may drop by the time they can sell them, and so they want to lock the current sale price, or a price close to it.

For example:

An oil company might know that in a year’s time they’ll have 100 barrels of oil ready for sale. Oil currently sells for $50 barrel, but the company is worried that the price of oil will drop in the year it’s going to take to process, package and prepare their barrels for sale. They arrange a futures contract with an interested second party to ensure that in a year’s time, they can sell the 100 barrels for a price that’s agreeably close to the current market price of $50 per barrel.

The next year then becomes a waiting game between the oil company and the second party, where the oil company benefits whenever the price of oil drops and the second party benefits whenever the price of oil increases.

What’s so special about Bitcoin futures?

Bitcoin has stirred global excitement, largely due to its volatility.

Futures contracts essentially allow those who trade in them to bet on the future price of various assets using their knowledge of said assets and the market in general, but Bitcoin represents a completely unknown quantity to most.

However, there are many people out there who think Bitcoin’s recently skyrocketing value is the sign of a bubble which is going to burst soon – leading to a huge plummet in the value of the currency.

It is argued that if those people are right and we are seeing a Bitcoin bubble, making the cryptocurrency more accessible in the form of tradable futures may not help either with the heightened levels of trading and investment already having led to yet another spike in its value.

Shorting Bitcoin; high reward, higher risk

The idea of a Bitcoin bubble has led to talk about the potential profits to be made off ‘shorting’ Bitcoin.

Shorting, or short selling, is an investment tactic which involves essentially betting that an asset’s value will drop.

In the case of futures contracts, this is done by selling a certain quantity of an asset via a futures contract when the asset’s value is high, and then buying back the futures contract after the asset’s value has dropped.

So for example:

A trader who’s feeling particularly bearish may sell a September contract for 20 Bitcoins, valued at approximately A$448,760. Say that by May, Bitcoin’s value has dropped and the contract is now worth only $300,000, the trader can buy back the contract and end up with the same quantity of Bitcoins they had before, having made roughly $148,000 in profit in the process.

This is a common trading strategy, and the idea of shorting Bitcoin futures in particular has been subject to a significant amount of debate lately, by both Bitcoin’s supporters and critics.

Some who are optimistic about the future of Bitcoin regard shorting it as foolish, with businessman John McAfee tweeting that “only an idiot would short Bitcoin.”

It’s a sentiment echoed by many on Twitter.

But whether you’re looking to short or long (i.e. invest in it with the hope of long-term increases in its value) Bitcoin, the currency’s volatility makes it difficult to pre-empt, and many are advising that institutional investors stay well away from Bitcoin for this reason.

Canstar General Manager, Wealth Josh Callaghan said only very experienced derivative traders who understand Bitcoin should consider it as an investment option.

“Bitcoin futures will be a welcome addition for existing Bitcoin holders wanting to hedge out some of the risk of a dramatic price drop, but for retail investors, this is very dangerous.

“Futures contracts are automatically highly leveraged as an investor only needs to put down a small upfront margin that obligates them to fulfill a transaction at a future date.”

Investing in Bitcoin has traditionally been a high risk/high reward move, and it’s unclear as of yet whether bitcoin futures will help or hurt the currency on that front.

The prevailing opinion for now seems to be that futures markets tend to help stabilise commodities by attracting speculation and an increased level of trading, and that Bitcoin will be no different – but only time will tell.

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