What are Bitcoin futures?

Bitcoin futures are contracts that commit to buying bitcoins or sell a certain quantity in the future at a price already stipulated by the parties in advance. 

Lthe markets of cryptocurrencies, They evolve rapidly taking advantage of the arrival of investors and new investment vehicles such as Bitcoin futures. Futures have proven since their inception to be a powerful market tool. Above all because they offer those who use them great flexibility and the opportunity to protect their investments.

But what are futures and what are their characteristics? How can Bitcoin investors and traders take advantage of this tool? Is it applicable to other cryptocurrencies? What about your regulation and your level of risk? Well, these and other questions will be answered below in this new chapter of Bit2Me Academy.

What is a Future?

When we talk about a future or futures market, we refer to a market in which contracts are created between different parties, which commits them to buy or sell in the future, a certain asset or financial asset in accordance with the provisions of said contract. These contracts have some data defined such as the quantity, price, expiration date of the operation. Upon expiration of these, payments are made according to what is stipulated in the contract.

These contracts are a type of derivatives trading contract, so we can find these tools within regulated and unregulated markets such as OTC (Over the Counter).

Despite the fact that futures markets are centuries old, today they are used to obtain profitability from a good negotiation between parties. Especially where exogenous circumstances and the environment determine the variability in prices, as is the case of the cryptocurrency market.

Origin of the Futures Markets

The origin of current futures or futures markets dates from a well-known protection system for agricultural producers in the XNUMXth century, the so-called “Forward”. Thanks to this system, producers were able to output their production at times of high production (harvests), regularizing and stabilizing prices, favoring the sale of their products and maintaining prices in the market.

However, its structure and operation date back to the 1730th century, more precisely from the city of Osaka in Japan in XNUMX. At that time, the Tokugawa shogunate dominating the eastern nation for more than a century, had mandated a well-established market infrastructure for future rice deliveries.

This economic infrastructure allowed the feudal domains to sell the rice they collected from the taxes on their territories to intermediary merchants through auctions and futures coupons that were delivered to the highest bidder. These rice coupons were very common, including those used for the rice trade that was transported to Osaka. Additionally, all these activities were recorded in a book in Dojima, marking the beginning of the first futures market: the well-known Dojima Rice Market.

The price of rice that was established in the Dojima Rice Market was published by messengers and through signs for hundreds of kilometers around, reaching the capital and other large cities. In addition, many of the trading rules and practices that were developed at Dojima were later used on the commodity, securities, and financial futures exchanges.

Later this tool was used to create the first modern futures market, which began its operation in the Chicago Grain Exchange, in the year 1848. At that time, the basic rules of commercialization and contracting operations began to be established. for future deliveries of agricultural products, as we know them today.

How does a futures market work?

To better understand how a future or futures market works, it is best to create an example scenario, so we could say the following:

Imagine that at this moment (August 2020) you want to buy 10.000 tons of rice from a producer for a price of € 450 per ton. For the purchase, you have decided to agree to a future contract worth € 4.500.000 and this contract will expire in July 2021. This means that in July 2021 you will be able to have access to that rice that you have bought and from there you will be able to sell it or use it as you wish.

At this point two situations can occur:

1. The price of a ton of rice has risen to € 550 due to a higher demand for rice and a low production of it.
2. The price of a ton of rice has dropped to € 380, due to low demand or an abundant production of it.

In the first case, if the price rises, your future contract will be a positive contract, since you have bought 10.000 tons of rice at a lower price than the market price (you bought at € 450 per ton, instead of € 550 per ton ) which generates a profit of € 1.000.000. While in the second case, it causes a loss because you have bought at a price higher than the current market value.

Of course, the conditions of the futures can be defined in different ways according to the needs of the parties, always betting on obtaining the best conditions. However, once these conditions are in place and the contract is expired, they will apply absolutely to the parties.

Futures Features

Now that we know what futures are and how they work, it is time for us to know their characteristics, and among these we can mention:

1. They are regularized markets with well-defined operations. Thanks to this, we have a legal framework that can protect us in different cases in which negotiations are distorted.
2. Everyone can participate in this market, and this is vital for them as they provide liquidity. In addition, these participants can be grouped as follows:
   1. Members of the exchanges: among them we can detail banks, investment companies, stock agents, financial brokers and official intermediaries.
   2. Arbitrageurs or professional clients: They are those who use the markets to protect their investments and inventories and who take advantage of the price distortions of an asset that is traded in different markets simultaneously.
   3. Hedgers: Those actors who seek to protect themselves from variations in the prices of products, with the mere objective of reducing possible losses in the different phases of the sale of a product. These would be: producers, exporters, cooperatives, etc. These normally use the futures markets to neutralize all kinds of risks.
   4. Individual or retail clients, also called speculators or investors: These are those players who buy or sell futures according to bullish or bearish expectations, that is, they try to take advantage of price fluctuations.
3. Futures markets offer a high degree of leverage which ends up having a multiplier effect on future profits or losses. At this point, the futures markets should weigh very well in case of leverage. Especially since these can lead to significant losses when the market is unknown.
4. The regulated nature of the futures markets has its figure in the Clearing House. This acts as an intermediary in the negotiation of the operation, trying to guarantee that the conditions of the negotiation are met and they operate with standard contracts for all.
5. Additionally, futures markets are very transparent markets. This is because the prices and market quotes are exposed daily.
6. Futures markets apply to different physical assets (commodities) and other assets of great interest to investors.

Having understood the concept of futures on the stock market and its market, it seems logical to understand that the most comfortable and agile way to operate is in futures. In addition, transparency, volatility and leverage make trading in the futures market a great option to operate.

Pros and Cons of Futures

The main pros of investing in futures are:

1. Initial costs: the costs generated in the futures contract are lower than for other financial instruments.
2. Liquidity: it is a financial product that offers liquidity.
3. Insolvency risk: the Clearing House guarantees the settlement of the contract.
4. Flexibility when negotiating: the agreement can be closed at any time before the expiration date.

While among its cons we can mention:

1. Market: there is no futures contract to cover all cash positions.
2. Maturity of operations: the market sets the expiration cycles.
3. Risk: it is a product that carries a high risk. There is the possibility of losing the entire investment.
4. Previous deposit: in this type of financial product it is mandatory to deposit a margin that covers a series of risks.

Bitcoin Futures How have the crypto market developed?

Bitcoin futures use the same trading scheme already described, only that on this occasion, the purchase or sale is around the variations in the price of Bitcoin. Investors often use futures in order to speculate on the price of Bitcoin in a regulated or unregulated financial market. All this while obtaining great leverage opportunities that help multiply your profits. However, the same situation can also lead to huge losses.

In addition to this, Bitcoin futures have a peculiarity compared to the futures that we usually see in the markets. This is that a good part of them are not subject to any regulation. This is understandable understanding that Bitcoin is a cryptocurrency and therefore it is not recognized as a security or legal tender in many countries, so there is a certain legal vacuum in this regard.

On the other hand, many companies that offer Bitcoin futures operate in an area with great legal uncertainties. This allows them to offer these products with more lax characteristics that end up attracting the attention of investors. A good example of this is BitMEX, an exchange that offers Bitcoin futures. However, for this and other activities he has obtained several calls for attention and orders for "Cease and desist" in different countries.

Currently, the most widely used regulated Bitcoin futures are Bakkt, CME and CBOE futures. But also, there are unregulated ones such as those offered by exchanges like BitMEX, Binance, OKex, Huobi, Kraken or Bitfinex. From the sheer number of options it may seem that these options are very safe and easy to use. But the reality is, that the highly volatile nature of cryptocurrencies like Bitcoin make futures a risky investment tool not suitable for the average user.

This, of course, does not mean that Bitcoin futures are not successful. In fact, its greatest success is in bringing the cryptocurrency market to regulated markets without major problems. There institutional investors and accustomed to traditional markets can enter into the activity of speculating on the price of Bitcoin without major problems. A situation that positively impacts the liquidity of the cryptocurrency markets. Especially because it improves the price of cryptocurrencies and diversifies their usefulness around the world.