Cryptocurrency futures are agreements between two traders to buy or sell an underlying asset at a future date when it reaches a specific price. This agreement exposes traders to the asset without actually owning it. They are similar to the futures contracts for traditional assets like stocks as they allow investors to speculate on the price movement of an underlying asset. They trade on crypto exchanges and some traditional markets.
Bitcoin is one of the most historically speculative, volatile, and risky financial assets. Unlike fiat, it has no central or government backing; as such, investing in it is different from traditional assets like stocks, bonds, etc. Factors like inflation rates, monetary policy tools, and economic growth measurements that affect fiat currencies don’t influence the value of Bitcoin. Instead, it serves as a store of value, with its price being affected by supply and demand, among other factors.
The supply of Bitcoin plays a pivotal role in determining its price. The scarcer an asset, the more likely high its price will be; however, an excessive asset is sold for less. During Bitcoin’s creation, it was stated that there would only be 21 million BTC ever, with a specific amount mined yearly. Asides from this, it will be halved every four years until it has fully been mined. Therefore, the price is expected to keep increasing with its limited supply.
With a limited supply, demand will undoubtedly cause a price increase. Due to being the first cryptocurrency, it is gaining adoption from retail and institutional investors. Similarly, its popularity has increased with the help of media coverage and expert opinions. Also, it is used as a store of value in countries with high inflation and devalued currencies. Although it still experiences bear and bull runs, demand remains a factor driving its price.
Like other assets, the price of Bitcoin is affected by production costs. Its marginal cost of production affects its price on crypto markets. The cost includes direct fixed costs of infrastructure and electricity for mining it and the indirect cost of solving its algorithm. Other cryptocurrencies also affect its price, including ETH, SOL, BNB, etc. They have helped increase the adoption of the blockchain, which has been beneficial to Bitcoin.
The price of Bitcoin is also affected by regulations. Due to being a new means of payment, it is bound to face regulatory backlash from the government and interested parties. The role of the media in driving Bitcoin’s price goes both ways as they keep investors and interested parties informed about the latest developments.
Bitcoin Futures and Bitcoin Price
Bitcoin futures contracts were first launched by Chicago Board Options Exchange (CBOE) on December 10, 2017, but it was discontinued. However, the Chicago Mercantile Exchange (CME) launched theirs about a week later. Bitcoin futures offer investors risk mitigation and hedging opportunities. The CME Bitcoin futures contracts offer monthly cash-settled contracts, allowing investors to take cash rather than Bitcoin when the contract expires through a brokerage. Market makers determine when trading begins by setting the initial price of the contracts.
Bitcoin futures mandates that one of two traders that agree to a contract will buy or sell BTC at a specific quantity, price, and date in the future. Bitcoin futures contracts derive their value from Bitcoin’s spot prices. Although Bitcoin futures and spot prices are different, they move in sync. Therefore, the prices of futures contracts are believed to follow spot prices. The price of Bitcoin futures is the sum of the spot price and the cost of carrying. Also, the price considers the risk-free rate over time until the contract is settled.
The settlement price can be affected by brokerage charges and market volatility. There are three reasons why the price of a contract changes, including decay, volatility, and changes to spot price. Decay is the cost incurred for rolling over contracts. It might be at the expense of investors. Decay is caused by the reduction in the contract price over time. The volatility of the spot price can lead to fluctuations in the contract’s price. The higher the volatility, the higher the price is likely to get. If the spot price of Bitcoin increases, the price of the futures contract will too. Say the spot price doubles, the price of the contract will nearly double.
While the companies launching Bitcoin futures continue to increase, these contracts are still impacted by the spot price of Bitcoin. With the adoption of Bitcoin, a lot of money is being poured into the Bitcoin market, making it more liquid and likely stable. The liquidity and stability will increase investment in Bitcoin futures contracts as the spot price will be somewhat stable. This would increase the volumes invested by retail and institutional investors since they will not need crypto wallets, addresses, or actual Bitcoin. Also, it will lead to the onboarding of prominent players without hesitation.
No matter how stable Bitcoin gets, the volatility will still be there. This volatility of Bitcoin’s price will make it easy for Bitcoin futures traders to hedge against it. They get to know their risks and returns. The changes in prices of Bitcoin across exchanges depending on events, and order book demand, among other factors, can make Bitcoin futures the strategy for investors as it is relatively safer than trading spots. Bitcoin futures has position and price limits that allow for risk mitigation.
The price of Bitcoin makes it easy for Bitcoin futures traders to evaluate how they want to enter and exit a trade. The price of Bitcoin provides another layer of complexity to valuing futures. Moreover, this volatility and uncertainty allow for profitable opportunities.
Asides from the CME, BTC futures can be traded on crypto exchanges like Binance, ByBit, FTX, OKX, etc. However, it should be noted that, unlike the CME, most crypto exchanges are not regulated, and position limit differs across exchanges. Bitcoin futures contracts offer traders regulated exposure to Bitcoin. It simplifies investing in BTC and is safer than owning BTC.