Understanding Bitcoin Futures Investment

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Understanding Bitcoin Futures Investment

Bitcoin futures are a recent innovation in the cryptocurrency investment scene. First made available in December 2017, they offer traders a fresh opportunity to invest in this emerging industry in a way which was, until that moment, only available for other assets. This guide will explain all you need to know about Bitcoin futures, including how to invest and useful tips.

What are Bitcoin Futures?

Although the concept of Bitcoin futures might keep novice traders away, they are a relatively simple financial instrument to understand. The first part of the term, Bitcoin, is quite straightforward and refers to the most popular cryptocurrency available for purchase in a variety of exchanges and platforms.

The next term, futures, refers to contracts which will come due in the future. Within these contracts, there is a sale agreement for a particular asset, which in this case is Bitcoin. As with any contract of sale, future contracts include the settlement date and price. The price is determined by the current value of the asset and by what it is predicted to be at the time of the settlement.

In addition, the contract also includes the exchange on which the contract is being sold or bought. The two parties who form make up the contract are split, with one planning to go long while the other planning to go short. When the due date is reached, the settlement of the contract is made in fiat currency or potentially cryptocurrency.

Trading futures is seen as providing a form of stability on the price of a particular asset. The more volatile the asset’s price is, the more attractive futures become. Know as hedging, this process enables businesses to secure a fixed, pre-determined price for a particular asset. Speculators, on the other hand, don’t really want to own the final asset but invest in futures in order to eventually sell them to businesses who seek them in exchange for a profit. Bitcoin futures are traded on futures markets, which have been around for decades. The act of trading futures is much older, with similar instruments traded as far back as 1710 in Japan.

How Bitcoin Futures Trading Works

While the exact process of trading Bitcoin futures varies depending on which platform you use, you would normally follow some or all of these steps:

  1. You begin by opening an account and depositing funds in that account
  2. Purchase Bitcoin futures
  3. Receive profits (or losses) once the futures contract is sold or comes to terms

The third step is the most significant part of the entire process, and understanding what factors can determine whether you will a profit or a loss is vital. The following are the main factors to consider.

Contract Size

The contract size shows the value of each individual contract. The value can be given in Bitcoin or can be shown in fiat currency.

Long vs. Short (Hedgers Vs. Speculators)

If you opt for a short contract, your balance will increase as the price of Bitcoin drops, and vice versa. On the other hand, if you opt for a long contract, your balance will increase as the price of Bitcoin also increases, and vice versa. Should you wish, you can opt to buy a mix of short and long contracts whose effect offsets each other.

Leverage

Available in a variety of advanced financial instruments, leverage allows you to magnify your investment capital by a multiple which can even rise to 50x or 100x. By using leverage you are trading on margin, which means that any drops or rises in your balance will be multiplied by the size of your leverage.

Expiration Date

The expiration date is simply the date when the futures contract will come to terms and must be settled. During the existence of a contract, it can be traded any number of times, but once its expiration date arrives, the person owning the contract must incur the costs. Expiration dates can, on occasion, be extended, and some Bitcoin futures contracts are perpetual, which means they don’t have an expiration date.

Why do Investors Opt for Futures Trading?

Generally, there are two types of investors who would trade Bitcoin futures. One type of investor would do so as a way to hedge Bitcoin’s value and protect their investment from market fluctuations. This type of investor would most likely keep the contract until expiration.

The second type of investor, the speculator, would seek the opportunity to buy and sell Bitcoin futures at favourable rates, turning a profit as a result. Such an investor would have no interest in owning the contract upon expiration. Speculation involves risk since there is no guarantee that an investor would find interested buyers for a contract. This is especially true if the cryptocurrency’s value suddenly drops, turning the contract into an expensive and overpriced investment.

How to Invest in Bitcoin Futures

When you are trading Bitcoin futures, you will not own the digital currency itself, so, using margin trading, you will only need to provide a small percentage of your invest in paid-up capital. If you decide to keep the contract until its expiration you will be required to cover the difference between the contract price and the actual price.

While you own a futures contract which hasn’t yet expired, you need to continually meet mark-to-market (MTM) calls. These calls are based on a difference between the cost of the held position and the current value of the cryptocurrency. This means that you might be required to add funds to your account to make up for this difference, and a failure to do so might lead to the closing of your position and the loss of your investment.

Another consideration for Bitcoin futures trading is the contract sizes. Contracts for 10 Bitcoin might easily exceed €70,000, which even with leverage are a sizeable investment. You need to consider whether you have the necessary funds to speculate on just one contract.

Collateral and Liquidation

When you’re trading on margin you are essentially trading using the broker’s funds, which are loaned to you. Your own funds are simple collateral for the loan. In cases where you don’t make use of leverage, you are simply trading with your own funds directly.

Margin trading is considered risky due to the fact that you could lose your money very quickly since any price movement is multiplied by your leverage. As a simple example, with a price difference of just 2% on a 50x leverage, your collateral disappears instantly.

In most cases, the platform which you use to trade Bitcoin futures will set a particular threshold upon which your position is instantly closed. Normally, this threshold won’t exceed 80% of your collateral, so that the platform will ensure that there are sufficient funds to cover closing fees.

Fees for Future Trading

Depending on which Bitcoin futures trading platform you use, you might need to pay some or all of the following fees. Before deciding on any platform you need to look closely at their fees, since these can quickly add up, removing any potential profits.

Trading Fees

Trading fees include a variety of charges linked to buying and selling of Bitcoin futures. Such fees can be named in a variety of ways, including commissions, but are only paid once you open or close positions.

Extension Fees

Extension fees refer to any costs needed to extend the expiry date of a futures contract beyond its original date. You might decide it is worth to extend the contract and pay the associated fees if you have reason to believe that the cryptocurrency’s value will shortly change in such a way as to provide you with a profitable return.

Overnight Fees

Depending on the platform that you use, you might need to pay to keep positions open beyond a certain time of day.

Interest Payments

Trading on margin is, essentially, taking out a short-term loan. As with any loan, you need to pay interest until the loan is settled.

Deposit and Withdrawal Fees

Again, depending on the platform, you might be required to pay either deposit and/or withdrawal fees. Sometimes, these fees are dependent on the payment method and/or currency which you use.

Where and How do Investors Trade Futures?

bitmex bitcoin futures
Screenshots are shown for illustration purposes only. Actual product may vary.

Increasingly, a number of reputable cryptocurrency exchanges are offering traders the opportunity to trade Bitcoin futures. BitMEX is one such exchange which has been offering Bitcoin futures since its establishment in 2014. Incorporated in Seychelles and operating from Hong Kong, BitMEX offers traders one of the largest volumes of Bitcoin futures. While the exchange is not regulated, it is considered to be extremely safe and trustworthy.

If you intend to trade Bitcoin futures on BitMEX, you should be aware of the following:

  • The cryptocurrency exchange offers trading opportunities 24/7/365.
  • You can choose from a variety of perpetual or standard Bitcoin futures. Standard Bitcoin futures’ expiry date is set quarterly or bi-quarterly.
  • BitMEX offers leverage trading up to 100x.
  • Apart from offering Bitcoin futures, BitMEX also offers future contracts for numerous Altcoins.
  • The exchange facilitates over $4 billion worth of trades daily and around $1 trillion annually.
  • BitMEX is not available in the United States, Cuba, Iran, and other countries. If you live in these countries consider a BitMEX alternative.

Can Bitcoin Futures Affect Bitcoin Trading?

While it is difficult to ascertain whether Bitcoin futures are independently responsible for any fluctuation in the price of Bitcoin, the release of such instruments in the past seems to have resulted in significant changes on Bitcoin exchanges. Considering more established markets, it does appear that there is a correlation between investment in futures and trading prices of underlying assets.

Today, the number of Bitcoin futures available is still low, when compared to similar instruments in more traditional markets. This means that, as yet, the number of investors and the eventual investment value is still proportionally low. As more Bitcoin futures become available, and more investors add to the investment capital, it is very likely that trading of Bitcoin futures will impact the Bitcoin trading in general.

A Note on Bitcoin Futures’ Safety and Regulation

The majority of exchanges which offer Bitcoin futures are, as yet, either completely unregulated or partially regulated. This is not to say that they are unsafe, only that cryptocurrency regulation in most jurisdictions is still lacking, leaving exchanges to self-regulate. In many cases, this has been proven to be a successful approach.

Reputable cryptocurrency exchanges implement a variety of Know Your Customer (KYC) procedures in order to manage the potential risk they are exposed to. Using industry-standard practices, not only in the cryptocurrency industry but also from Fintech companies and banks, reputable cryptocurrency exchanges seek to provide a safe and transparent service to their users.

Before you sign up with any exchange or broker you should always ensure that it is safe. In the case of regulated platforms, you can visit the regulatory authority to check for any issues in the past. For unregulated platforms, user reviews provide the best indication of whether a particular platform is safe or not. You must also ensure that trading cryptocurrency is legal in your jurisdiction. In fact, most exchanges will not onboard users from countries where trading cryptocurrencies is illegal or highly restricted.

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