Bitcoin futures contracts are a derivative asset 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 typically use futures contracts for speculation, but they can also be used for hedging. Hedging is especially popular among miners who need to cover operating costs.
Futures are a great way to diversify your portfolio, trade with leverage, and ensure relative stability in your future income. If you want to learn more advanced futures strategies, consider arbitrage. When implemented correctly, cash-and-carry arbitrage and inter-exchange arbitrage reduce trading risk.
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 of how they work to trade safely and intelligently. The advantage of futures is that they allow you to lock in prices through hedging and profit from market downturns through shorting.
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What are Bitcoin futures?
Bitcoin futures are derivative financial instruments similar to traditional futures contracts. In simple terms, you 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) a Bitcoin futures contract and the tick price is above the forward price on the expiration date, you make a profit. The mark price is the estimated fair value of an asset based on its spot price and other variables. We'll look at this in more detail next.
If the mark price is below the forward price at the time the futures expire, you lose money and profit on your short position. A short position means that a trader sells a borrowed or entirely owned asset, expecting its price to fall. Then, when the price of the asset falls, the trader buys it back and makes a profit. Contracts can be entered into physically by exchanging the underlying asset or, more popularly, through cash settlement.
Why do traders use Bitcoin futures?
One of the main uses of Bitcoin futures for both buyers and sellers is to use them to lock in future prices. This process is known as hedging. In commodity markets, where producers needed stable profits to cover their costs, futures were traditionally used as a hedging instrument.
In addition, traders use futures for speculation. Long and short positions allow you to bet on the state of the market. In a bear market, it is possible to make money by going short. Futures also offer opportunities for arbitrage and complex trading strategies.
Benefits of trading Bitcoin futures
Hedging
While hedging may seem more useful in real commodity markets, it can be used in cryptocurrencies as well. Bitcoin miners bear operating costs like farmers and rely on a fair price for their products. Hedging involves the use of both futures and spot markets. Let's see how it works.
Futures contracts
To protect his BTC assets, a Bitcoin miner takes a short position in the futures contract. Upon expiration of the futures contract, the miner is obliged to make settlements with the other party to the agreement.
If the price of Bitcoin on the futures market (the mark price) is higher than the forward price of the contract, the miner must pay the difference to the other party. If the mark price is below the contract's forward price, the other party in the long position pays the difference to the miner.
Spot market
On the day the futures contract expires, the miner sells his BTC on the spot market. This sale is made at the market price, which should be close to the mark price in the futures market.
However, trading in the spot market effectively cancels out any gains or losses made in the futures market. These two amounts provide the miner with the desired hedged price. Let's look at both steps in numbers.
Combining futures contracts and spot trading
The miner enters into a contract in the amount of 1 BTC for $35,000 for three months in a short position. If the mark price at maturity is $40,000, he loses the $5,000 he pays on the long position contract. In this case, the miner sells 1 BTC on the spot market, where the spot price is also $40,000. The miner receives $40,000, which covers his $5,000 loss, leaving him with $35,000 to hedge.
Leverage and Margin
An attractive opportunity for investors is margin trading. Thanks to borrowed funds, margin allows you to open larger positions than are available to the trader. Large positions generate greater profits because they magnify minor market fluctuations. On the other hand, if the market moves against the trader's position, the initial capital will be quickly liquidated.
On the exchange, leverage is displayed as a multiplier or percentage. For example, 10x multiplies the position size by 10 times. So, $5,000 with 10x leverage provides $50,000 to trade. When you trade using leverage, your initial capital that covers your losses is called margin. Let's look at an example:
You buy two quarterly Bitcoin futures contracts for $30,000 each. Your exchange allows you to trade with 20x leverage, so you only need to have $3,000. This $3,000 is your margin, and the exchange will cover your losses. If you lose more than $3,000, your position will be liquidated. The margin percentage is calculated by dividing the credit multiplier by 100. 10% – 10x, 5% – 20x, 1% – 100x. This percentage shows how much the contract price can fall relative to the target price before liquidation.
Portfolio diversification
With Bitcoin futures, you can further diversify your portfolio and try new trading strategies. It is recommended to keep a well-balanced portfolio containing a variety of coins and products. With futures, you can try many different trading strategies rather than simply storing assets. Additionally, there are lower-risk, lower-return arbitrage strategies that can reduce the overall risk of your portfolio. We'll talk about these strategies a little later.
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Bitcoin futures on Binance
Not all futures contracts are created equal. Futures products have different mechanisms, expiration dates, prices and fees on different exchanges. Binance currently offers several futures products that differ mainly in terms of expiration and funding.
expiration date
So far we have only discussed futures with a specific expiration date. The Binance Futures Exchange offers quarterly futures, and some other exchanges offer contracts with monthly and semi-annual maturities (expiration dates). From the name of the contract you can quickly understand its expiration date.
Quarterly Bitcoin futures contracts on the Binance exchange have the following calendar cycle: March, June, September and December. For example, the BTCUSD Quarterly 0925 contract expires on September 25, 2021 at 11:00:00 (Moscow time).
Another popular trading option is perpetual futures, which, as the name suggests, do not have an expiration date. Losses and gains are treated differently than quarterly futures and include a funding fee.
Funding fee
If you enter quarterly Bitcoin futures on Binance, you need to maintain a margin to cover any possible losses. However, you only pay for these types of losses after liquidation or expiration of the contract. With a perpetual futures contract, you pay or receive a funding fee every eight hours.
Funding fees are for periodic payments to traders. These rates prevent a divergence between the forward price of Bitcoin perpetual futures contracts and the mark price. The mark price is similar to the BTC spot price, but is designed to prevent erroneous liquidations that can occur when the market is highly volatile.
For example, a single trade in the spot market can temporarily raise the price by thousands of dollars. This volatility may cause futures positions to be closed, but does not reflect the actual market price. Below you can see the funding rate highlighted in red and its maturity date.
A positive financing 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 with long positions pay funding fees to short positions. A negative financing rate means that prices for perpetual contracts are lower than the mark price. In this case, short positions pay a commission to long positions.
To learn more about the funding rate and understand this somewhat complex topic, please visit the Introduction to Binance Futures Funding Rates section.
COIN-M and USDⓈ-M futures
Binance offers two futures options for trading: COIN-M margined futures and BUSD/USDT margined USDⓈ-M futures. Both contract options are open-ended, but there are some differences between them.
COIN-M futures use the contract's underlying asset as collateral for your futures margin account. USDⓈ-M futures allow cross-collateralization. Cross-collateral allows you to borrow USDT and BUSD at 0% using crypto assets from a spot wallet as collateral.
COIN-M futures are generally more popular among miners looking to hedge their Bitcoin positions. Since settlement is done through cryptocurrency, there is no need to convert BTC to stablecoins, which would add an extra step to the hedging process.
How to trade Bitcoin futures contracts?
If you want to start trading Bitcoin futures on Binance, all you need to do is create an account and have some funds in your account. Here's a step-by-step guide to opening your first Bitcoin futures contract:
1. Create a Binance account and enable 2FA (two-factor authentication). If you already have an account, make sure 2FA is enabled so you can transfer funds to your futures account.
2. To trade futures, you need to have BUSD, Tether (USDT) or other supported cryptocurrencies. The easiest way is to buy them using a credit or debit card.
3. Go to the Bitcoin Futures listing page and select the type of contract you want to buy. You can choose COIN-M or USDⓈ-M futures – perpetual or maturing.
4. Select a leverage amount that is convenient for you. This can be done to the right of the [Cross] button. Remember: the higher the leverage, the more likely it is that your position will be liquidated during small price movements.
5. To open a Bitcoin futures position, select the amount and order type you want to use and click [Buy/Long] or [Sell/Short].
For more detailed instructions, read the Ultimate Guide to Trading on Binance Futures.
Arbitrage strategies with Bitcoin futures
We've covered the basics of long and short trading, but that's not all you can do with futures. Futures contracts have a long history of arbitrage strategies, similar to the forex markets. These methods are used by traders in traditional markets, but are also suitable for cryptocurrencies.
Inter-exchange arbitration
Arbitrage opportunities arise because different cryptocurrency exchanges have different prices for futures contracts. By buying a contract on one exchange cheaply and selling another contract on another exchange for more, you can profit from the difference.
For example, imagine that BTCUSD Quarterly 0925 on Binance is $20 cheaper than on another exchange. By buying a contract on Binance and selling it on a more expensive exchange, you can make money by arbitraging the difference. Indeed, prices change quickly due to automated trading bots. You need to act quickly because by the time you make the trade, the difference may disappear. In addition, when calculating your profit, you should take into account any fees that you need to pay.
Cash-and-carry arbitrage
Cash-and-carry arbitrage in the futures markets is nothing new; it is a market-neutral strategy. Market-neutral positions involve simultaneous purchase and sale of an asset in equal quantities. In this case, the trader opens long and short positions of identical futures contracts for equal amounts, without taking into account their prices. Compared to traditional commodity futures, cryptocurrency futures offer significantly higher profit margins for cash-and-carry arbitrage.
Here you will find less efficient trading compared to older 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.
You need to simultaneously go short the futures contract and buy the same amount of Bitcoin on the spot market to cover your short position. When the contract reaches maturity, you can settle the short with the purchased Bitcoin and profit from the arbitrage.
What makes arbitrage possible? People are willing to pay a higher futures price if they don't currently have the money to buy BTC, but they believe its price will rise in the future. Let's say you think BTC will be worth $50,000 in three months, but it's currently worth $35,000.
At the moment you do not have the required amount, but in three months it will appear. In this case, you can go long at a small premium of $37,000 for delivery within three months. A cash-and-carry arbitrageur essentially holds BTC for you for a fee.
Trading can be simple
Summary
Bitcoin futures trading brings good old-fashioned derivatives from traditional finance into the world of cryptocurrencies. Crypto futures markets are extremely popular today and make it easy to find trading platforms with high trading volume and liquidity. However, trading Bitcoin futures involves high financial risk, so make sure you understand the mechanics of futures trading before you begin.
