To understand cryptocurrency futures exchange, it is of utmost importance to speak about what a future’s contract is. Futures contract fundamentally allows you to bet on a particular stock/asset without direct exposure, that is, without owning the stocks yourself.
What is a Futures Contract?
Simply defined a futures contract is a legally bound agreement where two parties decide to buy and sell an asset or security on a pre-decided date and time. Trading futures is one of the key elements of crypto trading.
The most important feature to remember here is that the buyer must acquire the asset once the contract has matured. The same rule applies to the seller. The seller has an obligation has to sell the assets once the date arrives.
Cryptocurrency futures are principally similar to a normal futures contract where people make a bet on what the price of the stock will be on a particular date. Crypto futures allow buyers and sellers to speculate over the virtual currency and make a bet on it on Redot and other crypto exchanges. Through crypto options, people are allowed to be exposed to cryptocurrency without actually owning them till the contract matures. This works for the buyer. We can say that cryptocurrency futures have a long way to go. Let’s find out why.
Profit maximization is not necessarily the primary goal of a futures contract. It is more of a risk management tool that can cushion the blow of a financial loss. We have to understand that risk management is particularly helpful when the asset being traded is volatile which perfectly resonates with the nature of the crypto market.
Two positions can be taken in the futures market. Due to their fundamental nature, we are speaking about a normal futures contract with underlying assets. They are:
- Long position- This is a situation where you are the buyer of the asset on a particular date in the future. Here you are betting for the market.
- Short position- This is the opposite end of the spectrum where you are the seller of a particular asset on a particular date in the future. In this case, you are betting against the market.
Let us try to put in a little bit of clarity into what a short or long position is.
- ABC organization needs oil to run their operations but they’ve predicted the price of the commodity to go up in a few months.
- Let’s that the price of oil was $1000 in January, ABC secured the purchase of oil at the same amount for the next quarter via a futures contract.
- Now suppose the price of oil went up to $1500 in April, ABC would have saved $500 by purchasing it in January via a futures contract.
- Honestly, this is not a bad scenario for the supplier because of the steady nature of the sale.
- Furthermore, they have protected themselves from the risk of loss if oil prices went down in the future by taking a short position that is if the prices of oil went down, they’d have already made a hefty profit.
- This is a win-win for companies.
How to Trade Futures
We have primarily discussed future contracts in this article which includes physical assets but futures are relevant for financial assets and cryptocurrency as well.
Everyone will agree that the crypto market carries a huge level of volatility inside it. Some traders manage their crypto assets by buying when prices drop and sell when they are high but it is always not possible to expect how low or high the prices would go. This translates to money being left on the table. On the other hand, Futures trading allows a level of flexibility and a good chance at making good money with crypto options.
The crypto futures trading works similarly to any other futures trading-
- You start by opening an account in any exchange or brokerage firm.
- Leverage is an important aspect to make a trade. This differs between exchanges. Binance used to offer up to 125 percent when futures trading was first launched. This has come down to 20 percent in 2021.
- Margin requirements and contract details are primary for bitcoin futures trading.
- The minimum collateral required to execute trades in your account is called margin. The higher the value of the trade, the greater is the margin required.
- Margin requirements may vary across brokerages.
- Cryptocurrencies can also be used as margins in some exchanges.
We can Speculate Market Direction through Futures trading. Short or long positions reflect the sentiments of traders towards a particular direction and becoming successful can make you influential and let you maximize profits.
Apart from this Bitcoin futures trading allow traders to speculate of the direction of the market where BTC is banned. BTC futures can also be traded in regulated exchanges and drive investment from people who are skeptical about the market’s lack of regulation. Example: The trading and clearing of Bitcoin futures are regulated by CFTC or the Commodity Futures Trading Commission who has exclusive jurisdiction over US BTC future markets.
There is no need for a digital wallet to trade BTC futures or Ethereum futures because it’s a financial settlement and does not require the exchange of Bitcoin.
Hedge Price Risk
We have already discussed short and long positions. An investor currently holding crypto assets may look to minimize risk by taking a short ‘future’ position in a market. The position will allow the owner to diminish the losses if the price goes down. This can be explained via an example:
- Person A owns a BTC valued at $60000 and enters into a Futures Contract which allows them to sell the bitcoin futures contract on Redot futures exchange at the current rate.
- If the price of bitcoin falls close to the settlement date so does the price of the Futures Contract.
- The person can now buy the Bitcoin Futures back.
- Let’s say the price of ETH had dropped to $30,000.
- The person can buy back the contract at a lower price after selling it at a high price
- The difference between them is the profit generated.
- Same works with Ethereum futures.