What are Bitcoin Futures? How do they work? – Forbes Advisor

Bitcoin (BTC) has experienced a meteoric rise in popularity over the past decade. Nevertheless, many investors remain skeptical of the cryptocurrency market due to its decentralized nature, questionable security, unclear regulations and extreme volatility.

Despite these drawbacks, Bitcoin took a big step towards legitimacy in October 2017 when CME Group, the world’s leading derivatives market, launched trading in Bitcoin futures contracts.

Four years later, ProShares made history again by launching a Bitcoin ETF based on futures contracts, the first ever crypto exchange-traded fund to receive regulatory approval to trade on a major US market.

Bitcoin futures offer investors a unique way to speculate in the crypto market and hedge their crypto holdings. But before you dip your toes into crypto futures, we’ll help you understand how they work and the risks involved.

What are Bitcoin Futures?

Futures are a type of derivative contract that obligates two parties to exchange an asset – or a cash equivalent – at a predetermined price on a future date.

When investors buy and sell Bitcoin futures contracts, they speculate on BTC’s future price. Essentially, two parties are betting: One believes that BTC will go up in price in the future, and another is betting that BTC will fall in price. The person who makes a mistake pays the other party a cash settlement.

There are various futures contracts, for currencies, stock indices and commodities. The Commodity Futures Trading Commission (CTFC) regulates the overall futures market, and the agency considers Bitcoin a commodity, so Bitcoin futures are commodity futures.

Bitcoin futures contracts are traded on the Chicago Mercantile Exchange (CME), which is introducing new monthly cash settlement contracts.

CME offers monthly BTC futures contracts for six months and additional quarterly contracts for each of the four upcoming quarters. CME Group also offers an additional December contract if only one is listed.

Each futures contract represents 5 BTC. Monthly futures contracts expire on the last Friday of each month.

Bitcoin Futures in the first month

Bitcoin’s short-term futures contracts are the contracts with the nearest expiration date. They are also called forward contracts for the first month.

First-month futures contracts typically trade close to the spot price of Bitcoin, and they can trade either above or below the spot price, depending on whether the market believes Bitcoin prices are headed higher or lower in the short term.

The price of Bitcoin traded on crypto exchanges is considered to be the BTC spot price.

Monthly futures contracts usually trade higher than the current spot price, a condition known as contango. Contango represents the market’s expectations that asset prices are heading higher in the short term.

Meanwhile, backwardation indicates that the market expects asset prices to trade lower soon.

How to Trade Bitcoin Futures

Because each Bitcoin futures contract represents 5 BTC, there is inherent leverage in the Bitcoin futures market.

Bitcoin futures traders often use this leverage to speculate on short-term fluctuations in the market in an attempt to generate large returns on relatively small upfront investments.

At the same time, futures contracts can also be an effective way of reducing risk. An investor with a large Bitcoin investment can sell a small number of Bitcoin futures contracts to insure against a crash in the Bitcoin market.

Bobby Ong, chief investment officer and co-founder of CoinGecko, says Bitcoin futures can be useful for both short-term and long-term investors.

“Due to the volatile nature of Bitcoin and cryptocurrencies in general, short-term traders can use Bitcoin futures to capture large gains during short bursts of increased volatility,” says Ong.

Long-term investors can also benefit from using Bitcoin futures contracts for speculative or hedging purposes.

Bitcoin ETFs and Futures

The Securities and Exchange Commission (SEC) and other regulators have been extremely cautious in their approach to Bitcoin and other cryptocurrencies.

The SEC has yet to approve a Bitcoin spot ETF that invests in the cryptocurrency directly for listing on a major US exchange.

Nevertheless, the SEC made history in 2021 when it approved the first Bitcoin futures ETF, the ProShares Bitcoin Strategy ETF (BITO), to trade on the New York Stock Exchange.

Instead of investing directly in Bitcoin, the BITO fund and other Bitcoin futures ETFs invest in a diversified basket of Bitcoin futures contracts.

Erik Anderson, senior research analyst for digital assets at Global X ETFs, says crypto futures ETFs have some advantages.

“U.S.-listed Bitcoin future ETFs provide investors with regulatory protections that do not exist on crypto-native exchanges and offer advantages of direct integration into traditional brokerage accounts, such as used in tax-loss harvesting,” says Anderson.

Are Bitcoin Futures a Good Investment?

Much like the cryptocurrency market itself, there are several pros and cons for investors when it comes to Bitcoin futures. Futures contracts can provide investors with flexibility, leverage and the potential to reduce risk via hedging.

But leverage can be a double-edged sword for investors, and futures trading losses can add up quickly if the market takes a bad turn.

In addition, Bitcoin futures traders are subject to margin calls that can trigger forced liquidation of their positions at the worst possible time if they cannot maintain the minimum margin requirements in their accounts. Bitcoin futures traders are also subject to exchange fees, which can affect trading profits.

Ryan Cullen, CEO of Cullen Cioffi Capital Management, says Bitcoin futures can be a useful tool for crypto traders. Nevertheless, it is crucial that traders fully understand and manage the risks involved.

“Because Bitcoin is quite volatile, and futures give you the ability to take a larger position, you can take advantage of short-term fluctuations in the market,” he says.

But he warns investors that the Bitcoin futures market is highly speculative. “Futures allow you to take on a huge amount of leverage, which means you can end up with an oversized position that ends up being worth very little or nothing.”