Crypto Futures

Trading futures contracts has taken place for more than a hundred years. Futures are often used by industry participants to hedge their investments in various assets and commodities, but speculators have also had a fair share of success leveraging their positions and trading these volatile derivatives. 

However, cryptocurrency futures are new, having only been in existence since 2017. Cryptocurrency futures operate much like traditional futures contracts where their price movement is determined by another underlying asset, but these contracts have a few differences that traders must grasp before stepping into the ring. For example, do you know how perpetual futures work in contrast to traditional futures contracts with expiration dates? If not, you’ll want to keep reading as the crypto markets have opened new avenues for profits, but only for those who truly understand the system.

What Are Crypto Futures?

Much like futures traded on traditional assets, crypto futures are a way to bet on the price direction of certain cryptocurrencies without holding the underlying tokens. A futures contract is an agreement between two parties regarding the future price of an asset. Each contract has a buyer (long position) and a seller (short position). 

The first crypto futures market was launched in 2017 when the Chicago Mercantile Exchange (CME) began allowing the trade of Bitcoin futures. Futures contracts were originally designed so market participants could hedge their risk exposure to certain assets like gold or oil, but they also have been a boon to speculators who can control large positions with only a fraction of the capital thanks to leverage.

Crypto futures can be traded on regulated exchanges like the CME and the Chicago Board Options Exchange (CBOE) and also unregulated cryptocurrency exchanges like Binance or Kraken.

>> Learn more about Futures Trading for Beginners.

How Do Crypto Futures Work?

Before discussing how crypto futures work, you need an understanding of perpetual futures. Most futures trading is initiated with contracts that have an expiration date where delivery or cash settlement must be accepted. In order to maintain a long-term futures position, contracts must be rolled over. Rolling over means selling the shorter dated contract and purchasing a longer dated one in order to keep the position open. A cash settlement option is needed for this strategy to work since one position is actually being closed while another is opened.

Perpetual futures don’t need to be rolled because they have no expiration. A perpetual futures contract is instead closed and reopened daily in an attempt to match as close to the spot price of the underlying asset as possible. A perpetual futures contract requires a daily settlement fee, which is the difference in spot price paid to either the buyer or seller of the contract. If the spot price of the underlying asset drops below the price on the contract, the seller collects the difference in a fee from the buyer. If the spot price rises above the price on the contract, the buyer collects the difference from the seller. This process is known as funding and happens every 8 hours on crypto futures markets. Perpetual futures make up the majority of cryptocurrency futures trading. Crypto futures with fixed expirations can still be found and traded, but perpetuals hog most of the volume.

If you want to get started with crypto futures trading, you’ll need to find a broker or exchange that offers it. Since crypto futures are available on regulated exchanges like the CME, many online discount brokers offer them to clients. You can also trade crypto futures on unregulated exchanges like Binance, BitMEX and Kraken. Unregulated exchanges carry greater risks but also allow more leverage and have a great selection of cryptocurrencies to speculate on.

You’ll need to select a broker or exchange for your futures trading and set up an account. Be sure to compare leverage and margin requirements and find one that meets your risk tolerance. Cryptocurrencies are volatile as is, and adding leverage is enough to give some traders whiplash.

Once you’ve opened your account, choose the token you wish to speculate on and initiate your position. Buying a contract means taking a long position; selling a contract is taking a short position. If you think the token will appreciate in value, you’d open a long position and accept the daily dividend from the seller if the spot price of the token rises. Positions can be closed out at any time.

>> See a list of Best Futures Trading Courses.

Benefits of Crypto Futures

• Exposure without owning any cryptocurrency: Why is this a benefit? For many institutions and market pros, cryptocurrencies are a compliance nightmare. But crypto futures are traded on regulated exchanges and allow institutional traders the ability to gain crypto exposure without getting called into an uncomfortable meeting. 

• Leverage: Derivatives traders use margin to control large positions with only a small percentage of capital. Currency and commodities markets are notorious for their leverage, but cryptocurrency takes it to another level. Not only are cryptocurrencies volatile as is, but crypto futures on unregulated exchanges like Binance can often be traded with leverage as high as 100-to-1.

• Hedging: Crypto futures allow traders to take a short position on different digital currencies, which makes hedging much easier to accomplish. If you own a lot of Bitcoin and want to protect yourself from a downswing, a short position using crypto futures is a good way to hedge.

• Flexibility: Institutional money managers often cannot trade on unregulated exchanges, nor can they invest in digital currencies like Bitcoin or Ethereum. But since crypto futures are contracts traded on regulated exchanges like CME, investors and asset managers at institutions won’t run afoul of their compliance departments.

Drawbacks of Crypto Futures

• Compounding losses: Leverage allows for profits that far outsize the original investment. Remember, however, that leverage is a two-way street. If you apply too much leverage and your trade turns sour, you could quickly lose a majority —  or all — of your investment. Margin calls are frequent in the crypto community since prices move with such volatility.

• Forced liquidations: Since there’s no central clearing party in a perpetual futures market, margins must be maintained or exchanges will liquidate positions. No crypto exchange will allow a position to reach bankruptcy levels. If liquidation is done for a gain, this profit will enter the exchange’s insurance fund, which protects against counterparty risk. Liquidations can have a cascading effect as more and more large positions are closed out, stimulating further price declines.

• Mismatched prices on unregulated exchanges: Exchanges outside the reach of U.S. regulators may have some appeal to crypto traders, but using them can create market distortions since there’s no centralized price mechanism. The price of Bitcoin on one exchange may differ from the price on another, which creates headaches for spot traders but really causes problems for futures traders.

>> Read more on the Best Futures Trading Software.

Compare Crypto Futures Brokers

Crypto futures are a relatively new type of derivative, but markets for them have been built for them quickly. If you’re looking to get started with crypto futures trading, you have plenty of options to choose from. Here’s a list of Benzinga’s favorites.

Crypto Futures are Extremely Volatile Derivatives

Trading futures isn’t for everyone. They’re volatile and complex and require a deep understanding of the underlying asset and current economic conditions. When you add in cryptocurrencies, which are volatile assets even before you use leverage, your risk multiplies.

Crypto futures trading requires a certain mindset for success. You need a high risk tolerance, a platform where you can successfully execute your trading plan and plenty of caffeine since these assets trade 24 hours per day, 7 days per week. Just be sure to completely understand how these derivatives work before purchasing them.

Frequently Asked Questions