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The advent of bitcoin futures in 2017, like everything else in the cryptocurrency world, sparked heated discussions. Bitcoin future is one of the popular forms of cryptocurrency derivatives under crypto futures.
Experts in the cryptocurrency world believe introducing an exchange-traded product will revolutionize bitcoin by allowing experienced traders and financial institutions to participate and regulate its system. This revolution allowed the advent of bitcoin futures.
Critics, however, plus the people in the future derivatives business, say that the arrangements are premature. Likewise, in worst-case conditions, it poses risk exposures due to the cryptocurrency market’s inherent uncertainty.
Here are some factors that you, as a trader, need to know.
What Are Cryptocurrency Derivatives?
From the term itself, derivatives are instruments that derive their value from an underlying asset. Derivatives are essential in traditional markets spanning countless generations, and their sophisticated version attributes from the 1970s and 1980s financial instruments.
Futures, forwards, and options are perhaps the most popular forms of typical derivatives, which are on the basis of investments such as shares, currencies, debt securities, and consumables. The overall market size is impossible to determine due to the vast amount of derivatives currently available. The estimates are ranging around trillions or over quadrillion dollars.
Likewise, secondary contracts in the blockchain are financial instruments that acquire their worth from a primary asset — widely known as cryptocurrency derivatives. Like any derivative that works in financial markets, it also works the same as a cryptocurrency derivative.
The principal commodity in this scenario, however, will be cryptocurrencies — like Bitcoin. Cryptocurrency futures, cryptocurrency options, and perpetuity contracts are perhaps the most successful emerging cryptocurrency derivatives.
How does Bitcoin Work in a Derivative Market?
Derivatives are contracts that you enter through a third party. Referring to Bitcoin, suppose you think the rate will eventually go up while someone else feels the price would drop. You, as the holder of bitcoin, with this third-party speculator, would negotiate.
Stipulated in your contract after a set length of time, either way, has to compensate the other according to the price difference. This agreement would be regardless of how the price has changed in any way.
The hedged item, which will be the bitcoin, would be protected by the hedged instrument, a derivative — in this case, bitcoin futures. Like any future derivatives, there will be gain or loss in this setup. This derivative works to offset the market movements of the financial commodity, therefore reducing the risk of losses due to unwanted price fluctuations.
What are Bitcoin Futures, and How Do They Work?
A Bitcoin future is essentially a contractual agreement between two parties to buy and sell Bitcoin at a specified price at a future time, as stated above. No side, in this scenario, is needed to maintain the underlying asset, Bitcoin.
Conversely, they just settle the transaction using US dollars or any other currency written in the contract. The particular settlement date differentiates futures contracts from those other derivatives instruments.
Investing in Bitcoin futures rather than the actual bitcoin has numerous advantages. For starters, the futures contracts are on an exchange trading platform governed by the Commodity Futures Trading Commission (CFTC), which will provide certain reassurance to massive investors.
Furthermore, since the futures contracts are cash-settled, there is no need for a Bitcoin wallet. Neither physical exchange the cryptocurrency, Bitcoin, takes occur during the transaction date.
Bitcoin futures, accordingly, allow traders to bet on the value of Bitcoin in the future. Additionally, investors may successfully interact with Bitcoin even if they do not currently own the currency.
The goal of Bitcoin futures trading is for a purchaser to secure a lesser price and a seller to engage in a better profit in a specified future. This type of agreement implies that there are no bitcoins involved in that process of the negotiation phase.
Obviously, this is due to the fact that futures are cash-settled contracts, in which the customer acquires the price of the bitcoin at the stated date and the seller collects the worth in cash. Likewise, Bitcoin itself is a cryptocurrency that does not totally exchange hands. But, the bitcoin futures are more secured in their own way.
The Difference Between Bitcoin Spot Market and Bitcoin Derivative Markets
A Bitcoin spot market enables investors, at any moment, to buy and sell Bitcoins but with certain constraints. In particular, traders may only profit if the worth of Bitcoin rises. Anyone possessing Bitcoin will lose money when the price falls.
Including those who were fortunate enough to trade it off before a major drop and want to repurchase at a reduced price requires prices to increase again. If they don’t, there’s really no way to make money. Another feature of spot markets would be that typically compel traders to retain the asset they would like to speculate on in their possession.
On the other flip side of the coin, a Bitcoin derivative market allows traders to trade the contracts that track the value of Bitcoin without really having to possess any of the cryptocurrency (as mentioned earlier).
The simplest way to explain this contrast is to use a tangible object as an example. Assume you want to make a profit by speculating on the price of crude oil. You may go out and buy oil barrels in person and then sell them whenever the price rises.
Without a doubt, this would be problematic and expensive since you’d have to account for maintenance and transit costs as well. However, trading a contract agreement whose price is linked to the price of crude oil would be a far superior strategy.
How Do You Invest in Bitcoin Futures?
Let’s take a look at how someone may trade Bitcoin futures. The term of the contract is among the first decisions a trader must make. It may be quarterly, semi-annually, and other choices available on exchanges.
Assume you wish to trade monthly Bitcoin contracts at a rate of $1,000, and every contract is valued at $10 in Bitcoin. This indicates that 1,000 contracts are needed to close a transaction worth 10 Bitcoin.
At this moment, a trader could either go long — think that its price is going up, or short — reckon that its price will go down. Whenever you establish a transaction, and in whatever way you prefer, the trading system effectively links you to somebody heading oppositely.
Once the contract is executed a month later, one of its dealers would be obligated to give payment. You turn a profit when you choose to go long, and the price moves up a month later. Unless the price has fallen, you have lost money.
Ultimately, Bitcoin futures might be a good method to get into Bitcoin sans needing to buy and keep coins. However, Bitcoin futures trading is typically not for newcomers due to its inherent high risk.
Bitcoin and cryptocurrencies, in general, are risky investments in themselves due to their volatility. Before you jump in, make sure you do your homework so you can select a dealer, devise a plan, and perhaps even interact with a trusted professional adviser who can help you.