Greetings traders and welcome back to another In-Depth with Chris episode. In today's discussion, we'll be covering Bitcoin futures. We're going to talk about what these derivatives of Bitcoin are, as well as where they came from, and some of the strategies that go into trading it. At the end of all this, you should understand exactly what the Bitcoin futures market place looks like and decide if maybe it's something that you're more interested in.
Either way, before we go any further, please do me a favor and click that like and subscribe button down below. It doesn't cost you anything and it helps me keep coming out with the content for you guys. Without further ado, let's get going. Bitcoin trading is a term that was close to non-existent just about a decade ago. But today,
it generates over 440 million search results in Google. These figures are about to skyrocket even further due to the introduction of Bitcoin futures. This is indeed arguably something quite good for the Bitcoin community. The Bitcoin futures will represent an instrument that blends the traditional financial world as we know it to the new digital revolution that is Bitcoin. For years,
Bitcoin trading was considered complicated, risky, and expensive, but nowadays, the cryptocurrency community's efforts have continuously brought Bitcoin more to a mainstream stage and has allowed for tremendous growth and promise for the Bitcoin traders around the world.
Let us first talk about what Bitcoin futures are. Bitcoin itself is a peer-to-peer version of electronic cash. We refer to it sometimes as "digital currency", and it was introduced by the mystic figure of Satoshi Nakamoto in the "Bitcoin: A Peer-to-Peer Electronic Cash System" paper
that was published in October of 2008. The cryptocurrency is mined with powerful computers that continuously solve complex math puzzles. This is part of a blockchain process. Bitcoin started attracting significant interest that led to the creation of a whole new industry of asset classes within Bitcoin itself.
Bitcoin allows investors to reap significant profits, but at the same time, is associated with higher volatility
and continues to be, even though the market is considered to be smoothing out. The digital currency is also technically more challenging to navigate, store, and operate when compared to common assets. Overcoming all of these challenges mean that the cryptocurrency industry would attract plenty of interest for those that are interested in where the future is going. The key industry movers have been making efforts to design and introduce Bitcoin futures into their accepted trading platforms, or as well as their accepted payment systems. Bitcoin futures are agreements to buy or sell the digital asset at a later date for a fixed price, just as we experience with other futures contracts. This allows traders to hedge against volatility and price swings between when the contract was bought or sold, and the moment it was delivered.
Besides this, Bitcoin futures also grant the opportunity to use leverage and maximize returns. Today, traders enjoy Bitcoin futures as they combine the best of both worlds: The chance to speculate and capitalize on the potential of the crypto currency assets, while also minimizing the risk and stabilizing the price fluctuations.
All of this without having to deal with the challenges like purchasing and storing the underlying currency. Instead, the futures contracts reflect the asset's value and the settlement is in cash. Although a slightly different form of Bitcoin futures has been around for quite some time, at first, they were traded mostly on unregulated crypto currency exchanges. At the end of 2017, the first official Bitcoin futures contracts started trading on a regulated exchange. In December of 2017, the CME, otherwise known as the Chicago Mercantile Exchange, and the Chicago Board Options Exchange, which is the CBOE, began offering futures contracts for Bitcoin's price. The CBOE's Bitcoin futures, which were referred to as XBT, were launched in December 11th of 2017, while CME's Bitcoin futures went live a week later. However, it was the CME's offering that triggered the more significant trading activity in this market. This was the moment when the broader financial community started becoming more open to the idea of cryptocurrency trading. The Bitcoin futures proved to be a major success right from the start, as traders finally had a tool that allowed them to capitalize on Bitcoin's price without owning the underlying asset.
It also proved invaluable to traders residing in jurisdictions that have banned crypto trading as a whole. The introduction of Bitcoin futures itself led to a 10% increase in the price of the underlying asset, which later than tame down. Here, we can see a graph of the value of Bitcoin since September of 2017. As we move our way along, we can see that we have a prediction line that overlays right about where price is, so it's almost hard to see.
Over here near the January 2018 bubble of Bitcoin, we saw the prediction to get a little higher during that temporary downswing, but after that, it more or less mirrored the real price. How do the Bitcoin futures work? Well, the Bitcoin futures contracts work in a similar way to grain, oil, or just other futures contracts in general, with the only difference being the underlying instrument, which isn't a physical asset, but instead it's a cryptocurrency that has a settlement in cash, usually in US dollars.
Unlike corn futures for example, there isn't a physical delivery of Bitcoin. Bitcoin futures allow investors to lock the cryptocurrency price and the hedge or profit from the high volatility associated with this particular asset class. If we were to say that we owned Bitcoin and the price was currently at, say $10,000 a coin, and we feared that the price will nosedive due to some uncertainties, we could protect our capital by selling a Bitcoin futures contract at the current price of $10,000. Close to the settlement date, the price of the contract and the underlying asset are expected to be lower. If for example, the Bitcoin futures contract trades at $8,000 close to the settlement date, we would have made $2,000 in profit, allowing us to hedge our Bitcoin portfolio. This allows us to open a door of possibilities when we own or already invest in Bitcoin, when we incorporate this kind of futures trading and futures hedging strategy, that is already employed with other futures contracts that may be things like grain, oil, or you name it.
The way the price of Bitcoin futures is calculated depends on the issuer of the instrument. In the case of crypto exchanges, like Kraken for example, the prices are based on aggregate indices representing the demand for each cryptocurrency from various exchanges. In the case of CME, it is based on the Bitcoin reference rate, otherwise known as the BRR, which serves as a once-a-day reference rate of the instruments US dollar price. It aggregates the trade flow of major spot exchanges during a one-hour window into the price of one Bitcoin in US dollars, as of 4 p.m. London time.
In most cases,
buying a Bitcoin futures contract doesn't require you to find a way to store the asset, as you don't technically own it. You're basically speculating with its price. However, there are venues, like BAKKT and Intercontinental Exchange, that offer daily and monthly Bitcoin futures contracts for physical delivery. Here, we have a Bitcoin futures contract from the CME Group. This is a relatively standard contract specification sheet for pretty much any futures contract. We can see that the contract unit is five Bitcoin, as defined by the CME CF BRR. The price quotation, like we said, is in US dollars. The trading hours are pretty standard for most CME futures in general. Then, we have the minimum price fluctuation of 5.00 per Bitcoin equaling $25, and a calendar spread of 1.00 per Bitcoin, meaning $5. The product code is "BTC" the whole way through, for Globex ClearPort and Clearing. Then, we have the listed contract settlement method and termination of trading. If you are interested in any of this information because you don't want to remember it, remember we have all of this available to you on our article on our site as well.
Much like other futures markets, we can use technical analysis or incorporate just about any strategy to trade Bitcoin futures, but there are two main strategies that traders like to employ. The first is called the cash-and-carry premium arbitrage. This is a market-neutral strategy and is intended to minimize risk and exploit pricing discrepancies in the spot price of Bitcoin futures. To apply the strategy, we should, first of all, start calculating the percentage difference between the Bitcoin futures price, and the current spot price of Bitcoin, at a certain point throughout the trading session. We can take this info from the data provider, if it is accessible or just simply start recording it on our own. We want to be consistent and put down
the difference in a spreadsheet every day. The more data that we collect, the better and more informed our trading decisions will be when we finally make them in the end. Once we get a clearer picture of how both of these variables correlate, we can kick off the real trading.
We will use this data to time the moment when the Bitcoin futures contract uncouples from the spot price. Traders who apply this strategy usually start by opening a long Bitcoin position and shorting a Bitcoin futures contract
for the same amount. Once the contract expires, the trader fulfills his obligations with the Bitcoin purchased initially. In the end, the trader pockets the difference between the Bitcoin spot price and the cost of the futures contract. This strategy should be applied only when the Bitcoin futures is considered to be expensive relative to the spot price and contributes to the creation of this arbitrage opportunity. Another popular Bitcoin futures trading strategy is called the inter-exchange arbitrage strategy. This strategy is usually applied by investors who trade Bitcoin futures that may be priced differently depending on the venue that they are trading on, Most of the time, this strategy is applicable to futures issued or traded on crypto exchanges.
Traders who apply the inter-exchange arbitrage strategy are seeking to exploit the pricing differences by capitalizing on the price gaps between the different platforms. They do this by buying their preferred instrument on exchanges where it is trading cheap and then selling on venues where it is trading at a higher price. Here, we can see an example of this with two different platforms on both the left and the right.
On the left, we have our OKEX, and then on the right we have our Deribit. As we can see, the instrument's price on OKEX is $16.7 cheaper than it is over on Deribit. In this case, the trader can buy the Bitcoin from OKEX and then sell on Deribit, pocketing the difference. The concept behind the strategy is relatively simple. We just have to have a keen eye and continuously scan the different crypto exchanges. The advantages of trading Bitcoin futures can be summed up with three main advantages, but is definitely not limited to just these advantages. These are just the top three in my opinion. The first is that it's suitable for all types of market participants. Large-scale investors, like funds or institutional asset managers, are attracted to Bitcoin futures, as they allow them to profit from the cryptocurrency market, which is otherwise unregulated and unaccessible.
Retail investors or small futures traders fancy the Bitcoin futures, as they're an easy way to speculate on the cryptocurrency market. Traders don't have to buy cryptocurrencies and ensure their physical storage by wallets and make new accounts on several exchanges in order to trade them, and as such, it is quite appealing to just about anybody. Then number two is that it is a regulated instrument when we talk about the Bitcoin futures. Bitcoins in their natural form are not regulated and they aren't stored in a bank or brokerage account, which means they aren't insured by the FDIC or the SIPC for example. With Bitcoin futures, things are different, as they are traded on an exchange regulated by the CFTC and they bring confidence to the investors and help build a healthier market environment in general. Then finally, we have the fact that they're financially settled. Although rarely held till expiration if applicable, some futures contracts may do so. With Bitcoin futures on expiry, the investor receives cash rather than physical delivery.
This eradicates the need to deal with the technological challenges surrounding the possession of cryptocurrencies including storage, transaction management, and the list goes on and on. As far as the potential disadvantages, we have that the price limits involved with Bitcoin futures may reduce our profits. Bitcoin futures on the CME have a price limit of 20%, either below or above the reference price. The idea is to better control volatility and minimize the effect of wild price swings, but this obviously can lead to an unfortunate situation for an investor that is looking to capitalize or stay in a position that is getting towards that 20% move. Number two is the Bitcoin futures can have a prolonged negative impact on the market. Although the price limit that we were mentioning is a useful tool in controlling volatility, according to some experts in the case of systemic problems, it can lead to a domino effect where many traders sell their futures contracts during an extended period of time.
That way, instead of a short-lived, one-time price jump or fall, this has a small to no impact effect on the exchange, and the effect is prolonged, and the instrument can then destabilize the market by leading to a snowball selling effect. To overcome this, some experts are pleading for the establishment of a separate guarantee to fund for Bitcoin futures to help isolate the risk. Then finally, we just have the simple fact of unstable pricing. Due to the fact that Bitcoin is still a relatively new and emerging marketplace, it works both for and against it, and can lead to unstable pricing scenarios where you see different prices, which do allow us to do those arbitrage trading techniques, like we talked about, so this could be seen as a positive or a negative. At this point, there's not much left to say about the Bitcoin futures market place, it's up to you to continue your education and explore the market yourself to decide if it's something that interests you. It may be, it may not, but my job is to bring you this information so you're more prepared and aware of what is out there for you.
But until next time folks, please make sure you do click that like and subscribe button below if you haven't because it does allow me to keep
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