Bitcoin Futures Explained (In Simple Terms)

The Bitcoin plot has taken another twist. And there is more to come from this epic journey.

The antagonists have entered the story, and the score is the sound of a bow being pulled across the strings of a cello.

In December 2017, the Chicago Board Operations Exchange (CBOE) and the cross-city counterpart Chicago Mercantile Exchange (CME) Group listed Bitcoin as a tradable asset.

Bitcoin Futures are here, and they are regulated. But nobody knows what impact they will have on the cryptocurrency market.

If you’re contemplating investing in Bitcoin or already have digital tokens in your portfolio, read on. You probably need to have Bitcoin Futures explained in detail.

Knowing which side of the boat to throw your line out could be the difference between massive savings and sickening losses.

Bitcoin Futures makes the star cryptocurrency a “legitimate” commodity – despite investors not actually owning Bitcoin.

Now, the leading cryptocurrency has marked its arrival on Wall Street, the future of the cryptocurrency market could be cut short.

Expert opinion is divided of course.

While some commentators think Bitcoin Futures will stabilise the market, others predict Wall Street will drive down the value of cryptocurrencies across the board.

Nafis Alam, an associate professor at Reading University in England and commentator of Bitcoin Futures explained:

“Futures trading gives new investors the choice to bet against Bitcoin and also allows them to settle contracts in dollars, boosting their liquidity. Plus, Bitcoin futures allow investors to trade off the cryptocurrency without actually owning it. This protects them from any volatility in the real-time spot market. This could reduce the demand for Bitcoin, pushing down prices.”

So what are Bitcoin Futures and why are they going to shake not only the cryptocurrency market but also Wall Street?

What Are Futures?

Futures are an age-old economic concept that dates back to the Babylonian King, Hammurabi.

The principle involves an agreement between two parties to buy and sell a commodity on a specific date for an agreed price.

This means the fixed price will be paid on the contract regardless of whether the real-time spot price is higher or lower.

As an investment tool, futures are a means of reducing the risk of investors in a volatile market. It works by traders speculating what the price of the commodity will be in the future then gambling other people’s money on their opinion.

For example, a trader will enter into a contract to buy corn for $1000 on 31st March. If corn is worth $2000 on the date the contract becomes active, the trader has saved his client $1000.

Of course, prices can drop, and corn may be cheaper, but this is the gamble you make.

There are two types of Futures traders; hedgers and speculators.

Hedgers protect themselves against future price drops and lock in a price. Then some speculators typically invest in long-term contracts in the hope the market turns in their favour.

While Bitcoin Futures still has its hedgers and speculators, the investment protocols work in a slightly different way because there is no physical commodity changing hands. Contracts are settled by cash only.

So, are Bitcoin futures any different?

What Are Bitcoin Futures?

In short, Bitcoin Futures enable traders to bet on whether the price of bitcoin will rise or fall by a specific date – without actually owning the token.

Essentially, it’s a game of “higher or lower” for Wall Street traders.

Bitcoin Futures are supposedly a way of regulating cryptocurrencies on the stock market.

The concept involves traders buying and selling contracts that predict the value of Bitcoin on a specific date. Although traders do not buy or sell digital tokens, the price of cryptocurrencies can still be affected.

The introduction of Bitcoin Futures poses three significant consequences.

Firstly, it means financial institutions officially regulate Bitcoin. This is good news for investors that have concerns about investing in cryptocurrencies in an unregulated market.

Secondly, it allows investors to earn (or lose) money on digital currency investments in countries that have banned the use of Bitcoin.

Lastly, Bitcoin Futures gives investment banks the “legitimate” right to manipulate the cryptocurrency market. Although there are measures to prevent market manipulators from affecting the markets, investment banks have more power to pull the strings of cryptocurrency.

Some members of the blockchain community might argue moving the Futures market into the cryptocurrency space will affect the price of cryptocurrencies.

The blockchain community hopes digital currencies will stabilise a seriously flawed financial system. But Bitcoin Futures may still enable that to happen naturally.

How Do Bitcoin Futures Work?

If you have not had Bitcoin Futures explained in simple terms, trying to fathom how it works through the mainstream press may leave you even more confused.

CME issued a statement in mid-December explaining how they will trade Bitcoin Futures.

  1. Each contract is composed of five bitcoin. (*Note: CBOE contracts only cover one Bitcoin at a starting bid of $10).
  2. The minimum fluctuation will be $5 per bitcoin, amounting to $25 per contract. Every time the contract moves by the smallest increment a trader will gain or lose $25 per contract they hold.
  3. There is a spot position limit of 1,000 contracts. Futures contracts always have limits on the number of contracts one person or entity owns. This prevents someone from being able to “corner the market.”
  4. Bitcoin futures will have a price limit of 20% above or below the prior settlement price.
  5. Price settlement will be based on the Bitcoin Reference Rate, or a daily reference rate of the US dollar price of one bitcoin as of 4:00 p.m. London time.

So what does this mean in layman’s terms?

Essentially, the market makers set a price for each contract that records the current rate of Bitcoin and dates the contract will end.

At the time of writing Bitcoin is trading at around €11,400.

Buyers and sellers then agree on a contract with a prediction of whether the price of Bitcoin will be higher or lower.

If the buyer says the value of Bitcoin will be higher by the agreed date, the seller is obligated to settle the contract for the difference.

Let’s say on 31st January Bitcoin has a market value of €12,400, the seller owes the buyer €1000. If Bitcoin is worth €10,000, the buyer owes the seller €1400.

Even though traders are trading on Bitcoin, no cryptocurrency is involved with Bitcoin Futures. The money that changes hands will be in fiat currencies – initially US dollars and then whatever currency investors want to convert them to.

To ensure futures are fulfilled, both parties that enter contracts are required to pay a holding fee on a daily basis depending on whether the price has gone in their favour or not.

This is what is known as a “settlement price” and acts as a guarantee should either party attempt to avoid payment on deadline day.

The issue with the Futures market is that prices can be manipulated.

For example, let’s say an investment bank has $20m worth of contracts on the table, but the value of Bitcoin is not in their favour.

To correct the problem, they buy $2m worth of Bitcoin. They will lose 2-3% on $2m, but stand to gain $2-3 on $20m.

The ledger against this happening is known as the Bitcoin Reference Rate (BRR) which, theoretically, is designed to make market manipulation difficult.

This yardstick, and others like it, is what makes the global stock market “regulated.”

The BRR calculates the average price of Bitcoin from multiple exchanges over the course of an hour. Whereas stocks can be changed in a second, it is harder to manipulate money markets for an hour.

Do Bitcoin Futures Affect The Bitcoin Price?

At the time of writing it’s too early to predict how Bitcoin Futures will impact the value of the digital currency.

The cryptocurrency is so volatile anyway; it’s difficult to predict whether influence coming from the global stock exchange will make any difference.

Experts don’t know either.

One camp says Bitcoin Futures will be the end of the Bitcoin and the cryptocurrency market in general, while others believe the adoption of Bitcoin as a regulated commodity is a signal that cryptocurrencies will be adopted as a legal currency in future eCommerce activities.

When Bitcoin Futures launched on the CBOE, it had a bullish start.

Tokens hit an all-time high of $17,382.64 after the first day of trading. All told, some $50m was shifted in the early three hours.

The price continued to escalate over the following week before peaking a few hundred dollars below $20,000.

Since then, Bitcoin has been on a steady decline and currently sits at $13.689.

However, some investors genuinely expect Bitcoin to rally once the Futures contracts from the first quarter of 2018 are settled.

The digital currency is expected to break through the $20,000 barrier at some point.

Analysis of historical data on the Futures market suggests bullish analysts will call it right.

Since data on futures was first collected in the 1970’s, we can see that the value of gold, silver and platinum surged considerably over a five year period.

It stands to reason that with more demand for Bitcoin Futures the prices of the digital crown currency will be pushed up.

But there could still be one more sting in the tale; gold, silver and platinum didn’t have rivals in the way Bitcoin does. And numerous altcoins will function in the real world far better than Bitcoin.

How Did Bitcoin Futures Affect The Cryptocurrency Market?

Bitcoin futures made their debut on the Cboe Futures Exchange from CNBC.

Wall Street analysts hope that regulating Bitcoin on the stock exchange will serve to strengthen cryptocurrency markets.

However, in reality, futures trading gives investors the opportunity to bet against Bitcoin without actually owning any.

Futures trading protects traders against the volatility of real-time spot prices, which could reduce the demand for Bitcoin in favour of Bitcoin futures.

The price of Bitcoin is, therefore, more likely to plummet.

The rapid descent started just before Christmas – less than two weeks after CBOE opened trading in Bitcoin Futures.

The price of Bitcoin has tapered off around the $11,000 mark. It will be interesting to see what happens over the next 10 or 11 weeks when the first quarter Futures are settled.

Some analysts think Bitcoin will stabilise, but commentators are less sure about competing altcoins.

The price of Bitcoin serves as the global standard for other virtual currencies.

Altcoins are typically traded against Bitcoin on an arbitrage basis to take advantage of favourable exchange rates.

Given there are cryptocurrencies that have better blockchains and business models than Bitcoin, investors are likely to buy altcoins – 2018 has been tipped as the year which will see a flurry of explosions in various altcoins.

As more retailers start taking advantage of cryptocurrencies, miners will switch their attention to computing the leading currencies to boost anticipated returns.

For Bitcoin owners, the option to replace their cryptocurrency for cash is an exciting option.

However, transferring their Bitcoins to a competing virtual currency waiting to explode is a temptation few investors will want to turn down now they have had a taste of the riches to be gained from virtual currency.

Where Can You Trade Bitcoin Futures?

As we mentioned above, investors can purchase regulated Bitcoin Futures from the two Chicago exchanges, CBOE and CME.

The other option is to purchase unregulated Bitcoin Futures from exchanges including BitMex and OKcoin.

However, they are not regulated, so the exchanges can set their prices and won’t fall under any legislation.

Final Thoughts

Now that conventional financial institutions have adopted Bitcoin as a legitimate investment, it is the first indication that there is a real-world future for cryptocurrencies.

However, the cryptocurrency remains something of a mystery and investing in such a volatile market makes Bitcoin Futures a real gamble.

The safer bet at this stage is to invest in altcoins, and although there are hundreds to choose from, backing tokens that are leading the altcoin pack to reduce the risk of losing out on your investment.

If you need more information on investing in altcoins, check our free Guide to Successfully Invest In Altcoins and ICOs.