TL;DR
Bitcoin futures contracts are derivative products that are similar to traditional futures contracts. Two parties agree to buy or sell a fixed amount of bitcoin at a certain price on a certain date. Traders use it speculatively, but you can also use it for hedging. Hedging is very popular among miners who need to cover their operational expenses.
Futures are a great way to diversify a portfolio, trade with leverage, and provide stability to future income. If you want to explore more advanced strategies with futures, learn arbitrage. Cash-and-carry arbitrage and inter-exchange arbitrage offer several low-risk trading opportunities when executed properly.
Introduction
Bitcoin futures contracts are an alternative investment opportunity to simply holding coins and tokens. As a more complex product, futures require a deeper understanding to trade safely and responsibly. Although they may seem more difficult to use, futures provide a way to lock in price by hedging and profit from declines in the market by shorting.
What are Bitcoin futures?
Bitcoin futures are financial derivatives similar to traditional futures contracts. Simply put, you can agree to buy or sell a fixed amount of BTC at a certain price (forward price) on a certain date. If you go long (agree to buy) on a Bitcoin futures contract and the mark price is above the forward price on the expiration date, then you will make a profit. Mark price is an estimate of the fair value of an asset drawn from spot prices and other variables. We will discuss this in more detail later in this article.
If the mark price is below the forward price at expiration, you will lose money and the short position will make a profit. A short position occurs when a trader sells an asset that has been borrowed or owned while hoping that the price will fall. Then, the trader will buy the asset at a later date to make a profit. You can settle the contract physically by exchanging the underlying asset or, more popularly, through cash settlement.
Why do people use Bitcoin futures?
One of the main uses of Bitcoin futures is the opportunity for buyers and sellers to lock in future prices. This process is called hedging. Traditionally, futures have been used as a hedging instrument on commodities when producers need stable profits to cover expenses.
Traders also use futures for speculation. Long and short positions allow you to guess market conditions. In a bear market, it is possible to still make money by taking a short position. There are also several opportunities for arbitrage as well as sophisticated trading strategies.
Benefits of trading Bitcoin futures
Hedging
While hedging may seem more useful in physical commodity markets, there are uses for it in crypto as well. Bitcoin miners have the same operational burden as farmers and they rely on getting a fair price for their products. The hedging process involves the futures market and spot market. Let's see how it works.
Futures contracts
Bitcoin miners can take a short position in a futures contract to protect their BTC holdings. When the futures contract matures, the miner must settle with the other party to the agreement.
If the price of Bitcoin in the futures market (mark price) is higher than the forward price of the contract, then the miner must pay the difference to the other party. If the mark price is lower than the forward price of the contract, the other party who took a long position will pay the difference to the miner.
Spot market
On the day the futures contract expires, the miner sells BTC on the spot market. This sale will result in a market price that should be close to the mark price in the futures market.
However, spot market trading will effectively cancel out any profits or losses made in the futures market. The sum of the two produces the hedging price desired by the miner. Let's combine these two steps to explain with numbers.
Combines futures contracts and spot trading
A miner chooses a short contract for one BTC at $35,000 in three months. If the mark price is $40,000 on the expiration date, he will lose $5,000 in settlements paid to the long position in the contract. At the same time, the miner sells one BTC on the spot market which has a spot price of $40,000 as well. Miner receives $40,000 which covers the loss of $5,000 and leaves $35,000, which is the hedged price.
Leverage and margin
An attractive feature for investors is trading on margin. Margin allows you to borrow funds and take a larger position than you would normally be able to afford. Larger positions will provide greater profits because small price movements are magnified. On the downside, your initial capital can be liquidated quickly if the market moves against your position.
Exchanges display leverage as a multiplier or percentage. For example, 10x multiplies your capital by 10. So $5,000 leveraged at 10x would give you $50,000 to trade. When trading using leverage, your initial capital will cover any losses and this is called margin. Let's look at an example:
You buy two quarterly Bitcoin futures contracts for $30,000 each. The exchange allows you to trade it with 20x leverage. That means you only gave $3,000. This value of $3,000 serves as your margin and the exchange will take a loss on this value. If you lose more than $3,000, your position will be liquidated. You can calculate the margin percentage by 100 divided by the leverage multiple. 10% is 10X, 5% is 20X, 1% is 100X. This percentage tells how much the price can fall from the contract price before liquidation.
Portfolio Diversification
With Bitcoin futures, you can further diversify your portfolio and implement new trading strategies. It is recommended that you create a balanced portfolio across various coins and products. Futures are interesting in terms of the variety of trading strategies they offer compared to just HODLing. There are also arbitrage strategies with lower risk and smaller profit margins that can reduce the overall risk of your portfolio. We will discuss this strategy further later.
Futures Bitcoin di Binance
Not all futures contracts are the same. Different exchanges have varying mechanisms, expirations, pricing and fees for futures products. Currently, Binance offers several options with the main differences in expiration and funding dates.
Expiry date
So far, we have only discussed futures with a specified expiration date. The Binance futures exchange has quarterly futures, but you can find monthly and semiannual maturities (expiration dates) on other exchanges. You can quickly check when a contract will expire from its name.
The quarterly Bitcoin futures contract on the Binance exchange has the following calendar cycle: March, June, September and December. The BTCUSD 0925 Quarterly Contract will expire on September 25, 2021 at 15.00.00 WIB.
Another popular option is trading perpetual futures with no expiration date. Losses and gains are treated differently than quarterly futures and involve funding costs.
Funding costs
When entering Bitcoin quarterly futures on Binance, you need to maintain margin to cover any possible losses. However, you will only pay these losses when you are liquidated or the contract matures. With perpetual futures, you also have to pay or receive a funding fee every eight hours.
Funding fees are peer-to-peer payments between traders. This rate prevents divergence in the forward price of a Bitcoin perpetual futures contract and the mark price. The mark price is similar to the BTC spot price, but is designed to prevent unusual liquidations that can arise when the market is highly volatile.
For example, a one-time trade on the spot market can temporarily increase prices by thousands of dollars. This volatility can liquidate futures positions, but is not very representative of the actual market price. You can see the funding levels highlighted in red below and their maturity times.
The funding rate means that the perpetual contract price is higher than the mark price. When the futures market is bullish and the funding rate is positive, traders in long positions will pay funding fees to short positions. A negative funding rate means that the perpetual contract price is lower than the mark price. In this case, the short position pays a fee to the long position.
To learn more about funding rates which can be quite a complicated topic, visit our Introduction to Binance Futures Funding Rates.
Futures COIN-M dan futures USDⓈ-M
Binance offers two options for trading futures: COIN-M futures with crypto as margin and USDⓈ-M futures with BUSD/USDT as margin. Both types of contracts are available as perpetual futures, but there are slight differences between them.
COIN-M futures must use the underlying asset of the contract as collateral in your futures margin account. However, USDⓈ-M futures allow you to use cross collateral. This feature allows you to borrow USDT and BUSD at 0% interest and use crypto assets in spot wallets as collateral.
COIN-M futures are generally more popular among miners who want to hedge their Bitcoin positions. Since the settlement is done via crypto, they do not need to transfer BTC into stablecoins which would add an extra step to the hedging process.
How to start trading Bitcoin futures contracts?
If you want to start trading Bitcoin futures on Bitcoin, all you need to do is set up an account and prepare funds. Here is a step-by-step guide to getting your first Bitcoin futures contract:
1. Create an account with Binance and enable 2FA (two-factor authentication). If you already have an account, make sure that 2FA is turned on so you can deposit funds into your futures account.
2. Get some BUSD, Tether (USDT), or a supported cryptocurrency for futures trading. The easiest way to do this is to buy it with a debit or credit card.
3. Navigate to Bitcoin futures overview and select the type of contract you want to purchase. Choose between COIN-M Futures (COIN-M Futures) or USDⓈ-M Futures (USDⓈ-M Futures) and whether they will be perpetual or will mature.
4. Choose the amount of leverage you are comfortable using. You can do this on the right side of the [Cross] button in the trading UI. Remember, the higher the leverage, the more likely you are to be liquidated by small price movements.
5. Select the amount and type of order you want to use, then click [Buy/Long] or [Sell/Short] to open a Bitcoin futures position.
For more detailed instructions, read the Ultimate Guide to Trading on Binance Futures.
Bitcoin futures arbitrage strategy
We've covered the basics of long and short trading, but that's not the only action you can take. Futures contracts are known to have arbitrage strategies similar to the forex market. Traders use this technique in traditional markets and this strategy is suitable for crypto as well.
Inter-exchange arbitrage
When different cryptocurrency exchanges have futures contracts at different prices, there is an arbitrage opportunity. By buying a contract on a cheaper exchange and selling another contract on a more expensive exchange, you can profit from the difference.
For example, imagine that a BTCUSD 0925 Quarterly on Binance is $20 cheaper than another exchange. By buying contracts on Binance and selling contracts on more expensive exchanges, you can arbitrage the difference. However, prices change quickly due to automated trading bots. You need to act quickly because any differences can be lost when trading. In addition, consider any costs that may have to be paid in calculating profits.
Arbitrase cash-and-carry
Cash-and-carry arbitrage is nothing new in the futures space and is a market-neutral position. A market-neutral position involves buying and selling an asset at the same time in equal amounts. In this case, the trader goes long and short the same amount on identical futures contracts regardless of price. Crypto futures offer much higher profit margins for cash-and-carry arbitrage than traditional commodity futures.
Trading efficiency is much lower compared to longer markets and greater arbitrage opportunities. To successfully use this strategy, you need to find a point where the BTC spot price is lower than the futures price.
At this point, take a short position with a futures contract and buy the same amount of bitcoin on the spot market simultaneously to cover your short. When the contract matures, you can settle the short with the purchased bitcoins and arbitrage the difference that appeared at the start.
So, why did this opportunity arise? People are willing to pay higher futures prices if they do not have the funds to buy BTC now but think the price will rise in the future. For example, you think BTC will be worth $50,000 in three months, but right now it is worth $35,000.
Right now, you don't have any money, but you will in three months. In this case, you could take a long position with a slight premium at $37,000 for delivery in three months. Cash-and-carry arbitrageurs essentially hold BTC for you for a fee.
Closing
Bitcoin futures trading takes the tried and tested derivatives of traditional finance and brings them to the crypto world. Crypto futures markets have become very popular and you can easily find trading platforms with high trading volume and liquidity. However, trading in the Bitcoin futures market involves high financial risks. So, make sure you understand the working mechanisms of futures trading before starting.
