How Do Bitcoin Futures Work?

Bitcoin trading

In December 2017, bitcoin futures were introduced on two leading derivatives exchanges in the US, the Chicago Mercantile Exchange (CME) and the Chicago Board Options Exchange (CBOE).

The approval of bitcoin futures by the US Commodity Futures Trading Commission (CFTC) has given the digital currency bitcoin the final stamp of approval needed for it to be recognized as a legitimate alternative investment for both institutional and private investors.

Furthermore, bitcoin futures have opened bitcoin up to a much wider investor audience since betting on the price of bitcoin is now easier than ever.

What are Bitcoin Futures? 

Futures, also known as futures contracts, are financial derivatives that oblige the holder to buy or sell an underlying asset at a predetermined price at a predefined future date. Futures contracts are always standardized, trade on exchanges, and detail the quantity of the underlying asset. Futures contracts may be settled in cash or by using physical delivery of the asset. Futures also provide investors with the opportunity to trade an underlying asset with leverage. In the case of bitcoin futures, the underlying asset is the digital currency bitcoin.

For example, an investor can bet on the price of bitcoin rallying in the new year by buying a bitcoin futures contract today that expires in March at the price of the current March futures contract. Let’s say this price is $16,000 and the investor buys one futures contract worth one bitcoin. Should the price of bitcoin be worth $20,000 when the futures contract expires in March, the investor makes a profit of $4,000 on his futures contract. Of course, the investor does not need to hold his futures contract until expiry. He or she can sell it at any time during trading hours on the exchange where the futures contract is listed.

The two bitcoin futures contracts found on the CME and the CBOE have slightly different standardizations but trade in the same manner.

 CMECBOE
TickerBTCXBT
Contract Unit5 Bitcoin1 Bitcoin
SettlementCashCash
CurrencyUSDUSD
Margin Rates35%44%
ClearingCME ClearPortOptions Clearing Corporation
Contract ExpirationsNearest two months in the March quarterly cycle (Mar, Jun, Sep, Dec) and one month not in the March quarterly cycle.The CBOE has listed three near-term months but intends to add more in the future.

You can find further information about the CME bitcoin futures contracts here and about the CBOE bitcoin futures contracts here.

What Does the Introduction of Bitcoin Futures Mean for Investors?

In simple terms, bitcoin futures allow investors to bet on the price of bitcoin without having to actually physically buy and store the digital currency. This greatly reduces one of the key risks of investing in digital currencies, namely, safe storage.

Furthermore, as bitcoin futures are exchange-traded, they could, in theory, become very liquid investment vehicles. This, in turn, could attract more institutional investors to this new digital asset class. So far, liquidity in bitcoin futures has been rather low compared to other commodity futures. However, as they were launched in December, a month in which trading activity is generally lower than in other months, liquidity will likely pick up in the new year.

Additionally, through the use of futures contracts, investors can now bet on the price of bitcoin declining by selling futures. This allows all the bitcoin “bears” to put their money where their mouth is and bet on bitcoin’s price decline.

More importantly, however, investors with exposure to digital currencies can now sell bitcoin futures to hedge themselves against a market crash. This will allow more institutional investors to gain exposure to digital currencies going forward as they can reduce their overall crypto asset market risk by shorting bitcoin futures.

Bitcoin futures are also a regulated financial product, which means that large institutional investors who are bound by right regulations are now able to bet on the price development of bitcoin by buying exchange-traded bitcoin futures. This opens bitcoin up to a much larger investment community than purely high net worth individuals and hedge funds, as has previously been the case.

Should You Buy Bitcoin or Bitcoin Futures?

If you are an active trader who wants to take profits through intra-day or intra-week trading of bitcoin, bitcoin futures might be the right option for you since you will be trading a relatively liquid, transparent, regulated investment vehicle. Also, in this case, the margin trading aspect of bitcoin futures contracts may play in your favor as investors can buy one futures contract but only need to put down 35 percent (CME) and 44 percent (CBOE) as initial margin for the trade. That means to buy exposure to one bitcoin futures contract on the CBOE (worth say $15,000), the investor only needs to pay $6,600 (44 percent) for the contract.

Currently, only a handful of brokers have enabled bitcoin futures trading for private clients. Ally Financial and Interactive Brokers are two of them. However, as the bitcoin futures market grows, more brokers will likely follow suit.

If you are a private investor looking to buy and hold bitcoin as a long-term investment, you are better off buying the digital currency itself and storing it securely in an offline bitcoin wallet rather than purchasing futures. Firstly, futures contracts are short to medium-term investment vehicles and secondly, when buying futures, investors are required to have funds in a margin account in case the value of the futures contracts drops. If the price drops to a certain level, the investor receives a margin call and needs to top up his or her margin account. Given the high volatility of bitcoin, margin calls will likely become a regular feature for bitcoin futures buyers. Hence, for long-term holders who are happy to hold their coins through the volatile periods, simply buying and holding the actual digital currency itself is the smarter option.

For institutional investors, bitcoin futures are the easier option to gain exposure to bitcoin and for many, it is the only option due to the tight regulatory requirement to which they need to adhere.

Perhaps the most impactful aspect of the launch of bitcoin futures contracts on the CME and CBOE is that it has opened bitcoin up to the entire institutional investment community. If institutional investors start to diversify into the digital currency, bitcoin’s price could easily end up a multiple of what it is worth today.

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