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What Are Bitcoin Futures and How Do They Work?

On December 18th 2017, two of the largest futures exchanges in the US – CBOE and CME – announced that they had been given provisional permission to list Bitcoin as a futures security.  This was a very important step forward, as it meant that Bitcoin was being allowed into the mainstream for the first time. Many people cited the way in which the two exchanges had been announced as it seemed that the Commodity Futures Trading Commission (CFTC), who is the agency responsible for governing them, was testing the waters for future BTC adoption.

Whether you’re interested in the crypto marketplace, or are generally involved with futures, you’ll want to consider the implications of BTC being offered by these exchanges.

What Are Futures?

Futures are contracts whereby a buyer and seller will agree to pay a particular price for a commodity at some time in the future.  The reason they exist is to ease the strain on producers / purchasers of commodities who may engage in seasonal, or at least cyclical, operations.  For example if a farmer that produces corn, will typically harvest their crop at one time during the year and a corn buyer who may want steady supplies. Since corn is typically harvested at the same time each year, the price at that time will be low.  This is good for the buyer but bad for the seller.  However, when there is no corn being harvested, the price will increase as stocks deplete.  This is good for seller but bad for buyer.

To counteract this natural flow in a market and to benefit of both parties, futures contracts set a standardized price that a company will pay for a commodity in the future. This means that the producer can create as much produce as is required, and the buyer can buy as much as they need without having wild fluctuations in the prices.

Whilst the futures market generally works well, there are times when it becomes problematic, such as when unforeseen crises occur or in the case of oil, where OPEC decide not to produce any for a certain amount of time. The important factor to remember here is that futures contracts are traded in exchanges around the US & the world. Traders bet on the future price of a particular commodity, hoping to make a profit if they hold a desirable contract.  For example, if an oil spill occurs and someone owns a comparable futures contract.

In terms of where Bitcoin fits into this picture, the idea is that if you want to purchase Bitcoin in the future, in order to predict its future price & retain some sort of stability in the market and this is why futures contracts were opened for sale on the asset.

Bitcoin Futures Contracts

Bitcoin Futures Graph

Bitcoin Futures

Bitcoin futures were created as a hedge against the future price of the asset.  In other words, it allows for traders to short the currency without actually owning any. This is important, as until the opening of these futures contracts, Bitcoin was ONLY available from secondary markets, which basically meant that you were only able to buy & sell them to other people directly. Whilst there’s nothing wrong with this, it’s ultimately a problem because since it’s almost entirely unregulated, the majority of institutional money (hedge funds etc) were unable to do anything with their clients’ money in the Bitcoin space.

The opening of the Bitcoin Futures exchange contracts has seemed to alleviate the pressure on many of the larger institutional funds.  The reason for this is because it meant they were able to effectively commit to buying BTC at a particular price in the future. If the price fell below that of the contract, the trader would be in profit but if it went against them, they’d have to take the loss. The important thing to remember is that it’s widely believed the futures contracts were opened to try and stop the rampant price increases of Bitcoin – which many have described as a bubble. Without actually getting involved with a regulated market, the price could be managed by the market itself.

 

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