Crypto Futures Trading, Explained

Crypto futures give investors the opportunity to bet on the future price of bitcoin without having to actually own or handle it.
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Ollie is the Learn editor for the Crypto Explainer+ section. He holds some SOL, RAY, CHSB and BTC.

Futures are a type of derivative trading product. These are regulated trading contracts between two parties and involve an agreement to purchase or sell an underlying asset at a fixed price on a certain date. In the case of bitcoin futures, the underlying asset would be bitcoin.

Futures allow investors to hedge against volatile markets and ensure they can purchase or sell a particular cryptocurrency at a set price in the future. Of course, if the price moves in the opposite direction a trader wishes, they may end up paying more than the market price for bitcoin or selling it at a loss.

In some circumstances, instead of actually buying or selling a cryptocurrency like bitcoin directly, which involves setting up a crypto wallet and navigating through complicated exchanges, futures contracts allow investors to indirectly gain exposure to bitcoin and potentially profit from its price movements.

Regulated bitcoin futures trading first debuted on the Chicago Board Options Exchange (CBOE), now known as the Cboe Options Exchange, in late 2017 and was soon followed by contracts on the Chicago Mercantile Exchange (CME). While the Cboe product has been discontinued, CME’s futures have since become a huge part of the crypto trading market. On Feb. 16, the rolling 24-hour notional value of all futures contracts across major exchanges in the U.S. and abroad stood at $26.9 billion. Notional value refers to the price of bitcoin multiplied by the number of futures contracts taken out by investors.

In 2021, CME reported an average daily volume of 10,105 bitcoin futures contracts, up 13% on the previous year.

So what’s so special about crypto futures trading?

How crypto futures trading works

There are three main components to a crypto futures contract.

  • Expiration date: This refers to the date when the futures contract must be settled. In other words, one party has to buy, and the other has to sell at the pre-agreed price. It’s worth noting, however, that traders can sell on their contracts to other investors before the settlement date if they wish.
  • Units per contract: This defines how much each contract is worth of the underlying asset and varies from platform to platform. For example, one CME bitcoin futures contract equals 5 bitcoins (denominated in U.S. dollars). One bitcoin futures contract on Deribit, however, equals 10 U.S. dollars worth of bitcoin.
  • Leverage: To increase the potential gains a trader can make on their futures bet, exchanges allow users to borrow capital to increase their trading size. Again, leverage rates vary greatly between platforms. Kraken allows users to supercharge their trades by up to 50x, whereas FTX reduced its leverage rates from 100x to 20x.

There are also two different ways futures contracts can be settled.

  • Physically delivered: Meaning upon settlement, the buyer purchases and receives bitcoin.
  • Cash-settled: Meaning upon settlement, there’s a transfer of cash (usually U.S. dollars) between the buyer and seller.

Crypto futures pricing

Although a crypto futures contract is supposed to closely track the price of the underlying asset, its value can sometimes vary throughout its maturation (as it edges toward its settlement date). This is usually caused by sudden sharp changes in volatility, which can be brought on by a fundamental catalyst such as Tesla buying up more bitcoin or a major country banning crypto. Supply and demand issues for specific contracts can lead to spreads widening or shrinking in one or more set of futures contracts compared to others.

Other changes in price include what’s known as “gaps.” These refer to periods of time on price charts where no trading is taking place – so there's no pricing data for those time gaps. They are only present on traditional platforms like CME because they have specific trading hours, unlike the wider crypto market that trades 24/7.

If a cryptocurrency’s price jumps significantly during the traditional market closing hours, large gaps can appear in the asset’s price chart on a traditional platform when the market reopens the following day.

Where can I trade bitcoin and crypto futures?

Over the last five years, the popularity of crypto-based futures products has grown exponentially, and now there is now a wide range of traditional and crypto-native platforms where you can begin trading crypto futures.

Leading examples of platforms that provide this type of trading include:

What’s the difference between futures contracts and perpetual swap contracts?

If you’ve been in the crypto industry for any length of time, you may have come across the term “perpetual swap contract.”

Perpetual swaps, or “perps,” operate in a very similar fashion to futures contracts in that they allow investors to purchase or sell an underlying asset at a future date, but with one key difference – perpetual swap contracts have no expiration date.

This means a trader can keep their contract to buy or sell open as long as they want – provided they keep up with margin payments – until they’re ready to settle them or sell them on to another trader.

Because these types of trading contracts have no expiration date, they require a special mechanism to ensure the contract price tracks the spot price (current market price) as close as it can. This system is known as a “perpetual swap funding rate” and essentially involves long (buyers) or short (sellers) traders paying the opposite party a periodic fee, depending on whether the contract’s price is above or below the market price.

If the market price is lower than the perp futures price, long traders will be required to pay a fee to short traders to discourage more traders going long. Conversely, if the market price is higher than the perps futures price, short traders will pay a fee to long traders.

Perp funding rates can often be a useful metric for gauging market sentiment around a particular asset.

Risks of crypto futures trading

Despite the many benefits of trading futures versus spot trading (buying and selling with immediate delivery of assets), such as indirect exposure and trading with leveraged to boost potential gains, there are also a number of serious risks associated with it that new investors need to be mindful of. These are predominantly margin calls and liquidation.

As previously mentioned, trading with leverage involves borrowing funds from a third party, usually the exchange you’re trading with, to increase your trade size.

Naturally, an exchange won’t let you borrow funds without putting up some sort of insurance in case the trade goes against you. This insurance pot is known as an “initial margin” that a trader has to set aside before they can open a leveraged trade. Just as your potential gains are turbocharged from using leverage, so are your losses.

But before we get into that, it’s important to understand three key parts of a futures trade:

  • Margin account: This is where the initial margin is kept (the minimum amount of collateral required to open a futures trade).
  • Margin calls: A margin call refers to when an exchange notifies a user that the capital in their margin account is getting low.
  • Maintenance margin: This is the amount of funds a user must have ready to deposit into their margin account if their initial margin runs out. Think of it as a backup fund.

In the event the market goes against a trader and their respective margin account is depleted, they incur something known as “liquidation” – meaning your position will be automatically closed by the exchange and your initial margin taken.

To find out how much the market has to move against you before you’re liquidated, the general formula is: Liquidation % = 100/leverage. So, for example, if you are leveraged 50x, the market only needs to move against you by 2% to liquidate your position (100/50 = 2). In the highly volatile crypto space, that means you run an incredibly high risk of being liquidated and losing your invested capital.

Of course, investors can always top up their initial margins to keep their positions open for longer in the hope the market moves the other way, but, again, this adds additional capital risk.

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This article was originally published on Feb 24, 2022 at 5:24 p.m. UTC

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Ollie is the Learn editor for the Crypto Explainer+ section. He holds some SOL, RAY, CHSB and BTC.

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Ollie is the Learn editor for the Crypto Explainer+ section. He holds some SOL, RAY, CHSB and BTC.

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