Summary
Bitcoin futures are a derivative product similar to traditional futures contracts. Where two parties agree to buy or sell fixed amounts of Bitcoin at a specific price on a specific date. Traders use it speculatively, but you can also use it for hedging. Hedging is especially popular with miners who need to cover their operating costs.
Futures are a great way to diversify your portfolio, trade with leverage and bring some stability to your future income. If you want to explore more advanced futures strategies, take a look at arbitrage. Short-forward arbitrage and cross-platform arbitrage offer some low-risk trading opportunities when implemented correctly.
the introduction
Bitcoin futures are an alternative investment opportunity to simply hold currencies and tokens. As a more complex product, they require a deeper understanding to trade safely and responsibly. Although more difficult to use, futures provide ways to stabilize prices by hedging and profit from market downturns with short selling.
What are Bitcoin futures?
Bitcoin futures are financial derivatives similar to traditional futures contracts. Simply put, you agree to buy or sell a fixed amount of BTC at a specific price (the forward rate) on a specific date. If you enter a long trade (agree to buy) in a Bitcoin futures contract and the index price is higher than the futures price on the expiration date, you will make profits. The index price is the estimated fair value of the asset derived from the spot price and other variables. We will discuss this in more detail later in the article.
If the index price is lower than the futures price at expiration, you will lose money and the put trade will make profits. A put trade occurs when a trader sells an asset that he has borrowed or owns while expecting the price to fall. The trader then purchases the asset at a later date to make a profit. You can physically settle contracts by trading the underlying asset or cash settlement, which is the most common method.
Why do people use Bitcoin futures?
One of the main use cases for Bitcoin futures is opportunities for buyers and sellers to lock in futures prices. This process is known as hedging. Futures are traditionally used as hedging instruments in commodity markets, where producers need fixed profits to cover their costs.
Traders also use futures contracts for speculation. Buy and sell trades allow you to bet on the state of the market. In a bear market, it is possible to continue making money by selling short trades. There are also multiple arbitrage possibilities and advanced trading strategies.
Advantages of trading Bitcoin futures
Hedging
Although hedging may seem more useful in physical commodity markets, it is used in cryptocurrency trading as well. Bitcoin miners have operating costs like farmers, and depend on getting a fair price for their products. The hedging process involves using both the futures market and the spot market. Let's review together how hedging works.
Futures contract
A Bitcoin miner can take a short position in a futures contract to protect his Bitcoin holdings. When the futures contract payment is due, the miner will have to settle with the other party to the agreement.
If the price of Bitcoin in the futures market (index price) is higher than the futures price of the contract, the miner will have to pay the difference to the other party. If the index price is lower than the futures price of the contract, the other party, who has a long position, will pay the difference to the miner.
Spot trading market
On the maturity day of the futures contract, the miner will sell his bitcoins on the spot market. This sale will give him the market price, which should be close to the index price in the futures market.
However, trading in the spot market will effectively cancel out any profits or losses made in the futures market. The two amounts together provide the miner with the hedging price they want. We will combine the two steps together to illustrate with numbers.
Combining futures and spot trading
If a miner sells one BTC contract at $35,000 in three months. If the index price was $40,000 on maturity, he would lose $5,000 in the settlement paid for the put position in the contract. Meanwhile, if the miner sells one BTC on the spot market, the spot price is also $40,000. The miner will receive $40,000, which covers his loss of $5,000 and leaves him with $35,000, which is the hedge price.
Leverage and leverage trading
An attractive feature for investors is carry trading. Leverage trading allows you to borrow money and enter into larger trades than you can normally afford financially. Trading larger positions results in larger profits, as small price movements are magnified. But the downside is that your initial capital can be liquidated quickly if the market moves against your trades.
The trading platform displays leverage as a multiplier or percentage. For example, 10x leverage multiplies your capital by 10x. So, $5,000 with 10x leverage gives you $50,000 to trade. When you trade using leverage, your initial capital covers your losses and this is known as leverage trading. Let's look at an example:
If you buy two quarterly Bitcoin futures contracts at $30,000 each. The trading platform will allow you to trade these two contracts with 20x leverage, which means you will only be depositing $3,000. This $3,000 will act as your borrowing trade, and the trading platform will collect your losses from this amount. If you lose more than $3,000, your position will be liquidated. You can calculate the carry trade percentage by dividing 100 by the leverage multiplier. 10% is 10 times, 5% is 20 times, and 1% is 100 times. This percentage shows how low the price is from the contract price before liquidation.
Asset distribution in the portfolio
Using Bitcoin futures, you can distribute assets in your portfolio and adopt new trading strategies. It is recommended to create a well-balanced portfolio using different currencies and products. Futures are attractive for the different trading strategies they offer you rather than just holding. There are also lower-risk arbitrage strategies with smaller profit margins that can reduce the overall risk to your portfolio. We will discuss these strategies in more detail later.
Bitcoin Futures on Binance
Not all futures contracts are the same. Different trading platforms have varying mechanisms, expirations, prices and fees on their futures products. Binance currently offers some options that differ mainly in expiry date and funding.
Expiration date
So far, we have only mentioned futures contracts that have a specific expiration date. The Binance futures trading platform has some quarterly futures contracts, but you can find monthly and semi-annual maturities (expiry dates) on other trading platforms. You can quickly check the expiration date of a contract from its name.
Quarterly Bitcoin futures contracts on the Binance trading platform follow the following calendar cycle: March, June, September, and December. For example, the BTCUSD 0925 quarterly contract expires on September 25, 2021, at 08:00:00 UTC.
Another popular option is to trade perpetual futures contracts without an expiration date. Losses and gains are treated differently compared to quarterly futures and include financing charges.
Finance fees
When you enter a quarterly Bitcoin futures contract on Binance, you should maintain your leveraged trade to cover any potential losses. However, you will only pay this loss when your position is liquidated, or when the contract matures. With a perpetual futures contract, you must also pay or receive a financing fee every eight hours.
Funding fees are person-to-person payments between traders. These rates prevent divergence between the forward price of perpetual Bitcoin futures and the index price. The index price is a price similar to the spot price of BTC but is designed to prevent unfair liquidations that may occur when the market is highly volatile.
For example, a one-time trade in the spot market can temporarily raise the price by thousands of dollars. This volatility can lead to futures trades being liquidated but does not truly represent the true market price. You can see the financing rate highlighted below in red and the maturity time.
A positive financing rate means that the perpetual contract price is higher than the index price. When the futures market is bullish and the funding rate is positive, long traders pay financing fees to short traders. A negative financing rate means that perpetual contract prices are lower than the index price. In this case, short position traders pay fees to long position traders.
To learn more about the funding rate, which can be a complex topic, visit Introduction to Binance Futures Funding Rates.
COIN-M futures and USDⓈ-M futures
Binance offers two futures trading options: COIN-M futures in crypto as a put trade, and USDⓈ-M futures in BUSD/USDT as a put trade. Both contract types are available as perpetual futures contracts, but there are some minor differences between them.
COIN-M Futures contracts must use the underlying assets of the contract as collateral in your futures carry trading account. However, USDⓈ-M futures allow you to use cross-collateralization. This feature allows you to borrow USDT and BUSD at 0% interest, using the crypto assets in your spot wallet as collateral.
COIN-M futures are usually more popular among miners who want to hedge their Bitcoin trades. Since settlement is done via cryptocurrencies, there is no need to convert BTC into stablecoins, which will add an additional step to the hedging process.
How to start trading Bitcoin futures?
If you want to start trading Bitcoin futures on Binance, all you need is to create an account and have some funds. Here's a step-by-step guide on getting your first Bitcoin futures contract:
1. Create a Binance account and enable two-factor authentication (2FA). If you already have an account, make sure you turn on two-factor authentication (2FA) so you can deposit funds into your futures account.
2. You must have some BUSD, Tether (USDT) or other supported cryptocurrencies to trade futures. The easiest way to do this is to purchase them using your debit or credit card.
3. Go to the Bitcoin futures overview and select the type of contract you wish to purchase. Choose between COIN-M futures or USDⓈ-M futures, and whether they are perpetual or maturity.
4. Choose the amount of leverage you prefer to use. You can do this to the right of the [Mutual] button in the trading user interface. Remember, the higher the leverage, the more likely your trade will be liquidated by small price movements.
5. Select the order amount and type you want to use, then click [Buy/Long Trade] or [Sell/Sell Trade] to open a Bitcoin futures trade.
For more detailed instructions, see The Ultimate Guide to Trading Futures on Binance.
Bitcoin futures arbitrage strategies
We've covered the basics of long and short position trading, but that's not all you can do. Futures have a long history of arbitrage strategies similar to the Forex markets. Traders use these techniques in traditional markets, but they are also suitable for trading cryptocurrencies.
Balancing between trading platforms
When different cryptocurrency trading platforms price futures contracts differently, there is an opportunity for arbitrage. By buying one contract at a cheaper trading platform and selling another at a more expensive one, you can make a profit from the price difference.
For example, imagine that a 0925 quarterly BTCUSD contract on Binance is $20 cheaper than on another trading platform. By buying a contract on Binance and selling a contract on a more expensive trading platform, you can offset the price difference. However, prices change quickly due to automated trading bots. You should trade quickly because any difference in price may disappear while you are making your trades. Also, you may have to pay any fees in calculating your earnings.
Balancing the immediate with the future
Offsetting short with forward is nothing new when it comes to futures contracts and are market neutral trades. These market neutral trades involve buying and selling an asset at the same time in equal amounts. In this case, the trader buys and sells an equal amount of identical futures contracts regardless of their price. Cryptocurrency futures offer a much higher profit margin for offsetting short with forward compared to traditional commodity futures.
There is much less trading efficiency compared to older markets and greater arbitrage opportunities. To use this strategy successfully, you must find a point where the BTC spot price is lower than the futures price.
At this point, simultaneously enter into a sell trade in a futures contract and buy the same amount of Bitcoin in the spot market to cover your sell trade. When the contract reaches maturity, you can settle the sell trade with the purchased Bitcoins and offset the difference you initially found.
So, why does this opportunity arise in the first place? Some people are willing to pay a higher futures contract if they do not have the money to buy BTC now but believe the price will rise in the future. Let's say you think that in three months BTC will be worth $50,000, but it's currently only worth $35,000.
At this moment, you have no money but you will have it in three months. In this case, you can enter into a buy trade for a slight premium of $37,000 for delivery in three months. The payment and transfer arbitrage tool essentially holds BTC for you for some fee.
Concluding thoughts
Bitcoin futures trading takes a tried and tested derivative of traditional finance and brings it to the world of cryptocurrency trading. Cryptocurrency futures markets are now very popular and one can easily find trading platforms with large trading volume and high liquidity. However, trading in the Bitcoin futures markets involves high financial risks, so make sure you understand how futures trading works before you get started.
