Futures are contracts which state the particular cost of an asset to be purchased or sold on a specific date.
Once approval was gained from both parties involved, the futures contract would be entered. Regardless of fluctuation on the asset’s price, both parties must carry out the transaction at a price agreed upon in the contract. Futures exchanges act as intermediaries to ensure that the negotiation and settlement would be conducted properly.
Futures contracts are initially presented as a tool for risk management. The financial markets are vulnerable to price fluctuations, and investors are looking for something that can protect them from sudden changes. Furthermore, these contracts are used in balancing out price variations on investment portfolios.
How It Works
Futures contracts allow parties to take on either a short or long position.
The long position is for buyers who agree to purchase an asset at a set price when the contract ends. Meanwhile, the short position is for sellers who decide to sell a particular asset at a negotiated price when the agreement expires.
Let’s use a real case application to understand further how futures agreement works.
The price of canola oil keeps on rising, and a national chain restaurant wants to ensure that it wouldn’t be affected by the price surge; hence, the company decides to strike a deal with a canola oil supplier. At current prices, a gallon of canola oil costs $5. The chain restaurant buys a futures contract, which, by agreement, would last for three months at $5000. Based on the contract, the chain restaurant can get 1000 gallons of canola oil when the deal expires, regardless if a price hike happens or not.
If the price of oil per gallon increased to $6, then the airline had efficiently saved $1000. For the part of the supplier, the futures contract ensures them of having a stable market for its products. The same agreement would also help the company gain firm profits even if the fuel’s price dropped unexpectedly. Simply put, a futures contract delivers the best interest of both parties.
However, some investors see futures contracts as a way to speculate within the associated markets rather than using it as a risk management tool. They will take on the long position when the price of an asset is low, and when there are clear signs of a price surge. As the price increases, these kinds of investors know that the contract’s value increases as well. To rake in profits, they will find other investors who are willing to buy the contract at a higher cost.
Bitcoin Futures, Explained
Futures contracts are not limited to physical commodities. They can also be used to trade financial assets.
Bitcoin futures contracts allow investors to speculate on Bitcoin’s price. Using the current price of the virtual currency as the basis, speculators can “bet” on what they think BTC’s price would be on a particular date in the future. Notably, investors who don’t own Bitcoin can also join the game.
However, there are two significant letdowns.
First, a Bitcoin futures contract can only be carried out on regulated exchanges. Notably, the cryptocurrency itself is surrounded by FUDs because of the issues that spring out from the absence of firm of regulations. However, this set up proves to be beneficial to those who want to mitigate the risks associated with the industry.
Second, Bitcoin futures contracts enable investors to place their bets even if they live in a place where there is a Bitcoin ban.
How Does Bitcoin Futures Work?
Bitcoin futures contracts apply the principles of the same future used by traditional financial assets. Most speculators observe the markets and look for signs before deciding what kind of position to take on the futures contract.
For instance, if an investor has $10,000 worth of BTC and thinks that price will plummet in the months to come. To avoid a significant potential loss, the investor can sell the contract at BTC’s current price. If BTC’s price dropped suddenly as the agreement heads towards expiration, the value of the futures contract would suffer as well. The smart investor will then purchase the Bitcoin futures back at a lower price, say $9,000. Now that’s an easy $1,000.
This situation explains how the setup of Bitcoin futures contracts works. However, investors must be wary that the futures exchanges have different terms and price limits, and others have complicated procedures.
The Connection of Bitcoin Futures to the Price of BTC
In the short position, Bitcoin futures contracts work as a price surge catalyst as the overall interest in the crypto asset increases.
On December 2017, the Chicago Board Options Exchange launched Bitcoin futures. It was the first regulated exchange in the industry to do so. The next day, the industry was stunned to find out that BTC’s price soared by almost ten percent.
The same thing happened when the Chicago Mercantile Exchange launched its Bitcoin futures contracts. CME is one of the biggest exchanges in the world. In an instant, Bitcoin managed to outperform its $20000 price barrier. Although the long-term impact of Bitcoin futures to Bitcoin’s value is more challenging to predict compared to short-term, there are indicators that these contracts would continue to propel the price of BTC.
Here are some of the reasons why there is a likelihood of a price surge:
- Public exchanges regulate Bitcoin futures, meaning there are fewer risks. Skeptical investors can be convinced to trust the process.
- There’s a likelihood that institutional investors would advise their clients to buy futures contracts as a form of practical investment.
- Bitcoin futures enhance the market’s liquidity, making the process of crypto buying, selling, and trading more manageable and more profitable.
- It makes the Bitcoin marketplace more accessible, even to those investors who live in places where there are bans and restrictions.
With the prime objective of balancing out sudden changes in prices of underlying assets, Bitcoin futures effectively lessens the volatility of BTC’s price.
The Impact of Bitcoin Futures to the Blockchain Industry
There are different visions.
Bitcoin is the world’s most famous cryptocurrency. Whatever happens to its price and value, the world always takes notice. Regardless of the price catalyst, a surge in Bitcoin price lures more and more enthusiasts. As this happens, the value of associated assets such as altcoins tends to increase as well. However, there is also a possible flipside.
Altcoin investors who are eager to take part in Bitcoin’s bullish market might decide to sell their crypto assets. If this happens on a large scale, it can profoundly impact the price of these alternative virtual currencies.
It is possible that leading altcoins such as Litecoin, Ripple, and Ethereum would launch their respective futures contracts as well, when the investors’ interest is sufficient enough to establish a lucrative market.
Options for Bitcoin Futures Trading
Interested Bitcoin futures investors have two options.
The first market is facilitated by selected crypto exchanges such as OKCoin and BitMEX. While the offerings have been running on for quite some time, it is essential to note that most of Bitcoin futures trading on these platforms remain unregulated.
The second market is offered by exchanges which are publicly regulated. This option provides a fresh perspective, and it immediately gained the interest of investors. A notable surge in Bitcoin’s price was witnessed last December, following the decision of CBOE and CME to launch Bitcoin futures contracts. Other big firms such as JP Morgan and TD Ameritrade have given signs of possible run-ups.