What Is Futures Trading in Crypto and How Does It Work?
There are many ways to get exposure to cryptocurrencies, but futures trading is one of the most popular and convenient approaches. Here are all you need to understand the intricacies of futures trading better. In which it can provide better opportunities compared to spot trading and options trading. To know how to open long and short positions on multiple digital currencies. Here’s exactly what you need to know.
Futures trading refers to a method of speculating on the price of assets, including cryptocurrencies, without actually owning them. Like commodity or stock futures, cryptocurrency futures enable traders to bet on a digital currency’s future price. Needless to say, Bitcoin futures are currently the most popular type of crypto futures contracts.
How Does Futures Trading Work?
If you had watched the process of cryptocurrency futures trading on a crypto exchange platform like Bybit, you wouldn’t tell the difference from regular trading. That’s mainly because traders do precisely the same thing in both cases – open long and short positions and implement proper risk management techniques.
However, futures contracts are very different from spot trading because they don’t operate with the underlying assets but only with their price action. Without the actual asset, futures are way more fluid and easier to handle. Also, they enable margin trading with high leverage.
What Is a Futures Contract?
Initially, futures contracts made sense for many commodities, including foods, oil, and metals. However, they soon went beyond their practical reasons to conquer all financial markets, including cryptocurrencies. Today, most commodity price quotes you see on financial portals involve futures, usually with a monthly expiry date.
In a nutshell, a futures contract is an agreement between two parties to either buy or sell an asset, such as digital currency, on a predetermined date, at a predetermined price. The contract tracks an underlying asset, be it a commodity, stock, or cryptocurrency. It is basically a form of bet on the future price movement.
For example, if you think that Bitcoin (BTC) will increase in price by the end of the month, you would be interested in opening a long position on the cryptocurrency by buying a Bitcoin futures contract with a monthly expiry date. Otherwise, if you believe Bitcoin’s price will go bullish, you would go long. At the contract’s expiry date, the two parties involved in the trade settle, and the contract closes.
While a futures contract’s condition is to have an expiry date, there is a subcategory of cryptocurrency futures called perpetual contracts. What separate perpetual contracts than the rest is it does not have any expiration. They behave exactly the same as traditional futures but without any expiry and settlement.
The price of a perpetual contract monitors the cryptocurrency spot price and trades very close to it. The primary mechanism making perpetual contracts possible is the funding rate, in which long and shorts make regular payments to each other depending on the market situation.
Types of Cryptocurrency Futures Contracts
There are several types of futures contracts that crypto traders can choose from. It’s worth mentioning that most platforms do not provide all of the listed types, so make sure to select the suitable futures exchange.
Standard Futures Contracts
Regular cryptocurrency futures have all the aspects of a standard futures contract from traditional markets, including expiry and settlement. Chicago-based CME Group and CBOE were the first futures trading exchanges to launch Bitcoin futures contracts back in December 2017. In fact, this was one of many reasons that boosted the BTC price to a record high at the time, until BTC price reached broke its all-time-high of $20,000 in 2020.
Today, CME provides several Bitcoin futures with different expiry dates, as seen in its Bitcoin Futures Calendar. All contracts are settled in U.S. dollars at the expiry. Elsewhere, CBOE decided to abandon its Bitcoin futures contracts, but it would definitely bring them back soon as the interest in crypto is surging.
On the contrary, some crypto exchanges do provide standard futures contracts. Like Bybit, FTX, Deribit, and Binance, most of them offer quarterly Bitcoin futures and the contracts commonly dealt with in U.S. dollars. They are often settled every three months and are ideal for swing trading.
Futures with Physical Delivery
Another type of cryptocurrency futures that also have expiry dates are futures with physical delivery. They were first introduced by Bakkt, an entity backed by Intercontinental Exchange (ICE), the parent New York Stock Exchange (NYSE). The only difference from the regular futures described above is that cryptocurrency is actually delivered during the settlement process.
Bakkt now offers only Bitcoin futures with physical delivery, meaning that it transfers Bitcoin at the expiration date to those who bought futures on the cryptocurrency. As a cash-settled futures contract, this approach aims to contribute to the Bitcoin circulation.
Perpetual contracts represent another popular type of cryptocurrency futures. Since it does not rely on the expiration date, perpetual contracts quickly took off on BitMEX, but soon being adopted by major crypto exchanges, including Bybit, FTX and Binance.
The primary mechanism that helps perpetual contracts keep as close to the spot price as possible is funding. Traders are paying each other based on their open positions at certain hours. The difference between the perpetual contract price and the spot price decides who pays and who gets paid. Thus, when the funding rate is positive, traders who have long positions pay shorts, and when the funding rate is negative, shorts pay longs.
The cypto perpetual futures market has grown rapidly, but there is still room for improvement in the trading volume compared with conventional futures exchanges.
Despite the large drop in crypto prices in 2022, trading volume for perpetual futures has slumped but they have not been affected as much. According to coinglass data, average futures volume still range around $50b - $200b.
Crypto futures will continue to be an area with huge potential and will be hugely contested amongst the top exchanges as well as decentralized exchanges.
Commodity vs. Crypto Futures: Similarities & Differences
Bitcoin futures share many similarities with futures contracts from traditional financial markets. In fact, Bitcoin is considered a commodity by the U.S. Commodity Futures Trading Commission (CFTC), so this shouldn’t surprise you.
Futures on both cryptocurrencies and commodities do not involve the underlying assets, but the price of those assets. Most of the time the derivatives and the underlying asset prices are almost the same price. There are futures from both markets that share similar components, including the expiry date and settlement.
Some cryptocurrency futures, such as perpetual contracts, are different from commodity futures because they don’t have any expiry time and settlement. Plus, crypto futures are generally more volatile than commodity futures, given that digital assets are way more volatile.
Another key difference is that many commodity futures are traded for practical reasons rather than for speculation. For example, factories and transport services would be interested in buying oil at current prices, but they would purchase oil futures with future delivery.
Futures vs Options Differences
Both Bitcoin futures and Bitcoin options are available to be traded on Bybit as well.
Futures contracts can be useful for speculative traders but have a real utility for individuals and organizations that deal with the actual underlying assets, allowing them to hedge operational and business risks from unforeseen market movements and volatility.
The most common example is that of Bitcoin miners. They generate revenue from the Bitcoin they mine and sell, however the value of Bitcoin can fluctuate widely even though their costs are relatively fixed and often paid in fiat.
If Bitcoin's price declines significantly in the future, the miners' ability to meet their fixed costs is adversely affected, potentially jeopardizing their operations.
In order to manage this risk, miners can turn to the futures market and find future buyers for their Bitcoin at prices that will allow them to continue operating profitably. Options contracts, on the other hand, are more suitable for speculation traders as it comes with limited downside risks.
Both Bitcoin futures and Bitcoin options are available to be traded on Bybit as well.
The Benefits of Futures Trading
Cryptocurrency futures have become very popular and for excellent reasons. Here are some advantages of crypto futures that you should consider:
- Convenient. Trading futures is easy even for beginners than trading actual cryptocurrencies, which requires you to access a liquid market and have a secure digital wallet. In fact, this is why the trading volume in crypto futures is two to three times larger than spot trading volumes.
- Higher potential profits. When trading crypto futures with leverage, the gains are typically more substantial. On Bybit, you can set the leverage up to 100x, meaning that you can enter a position worth $1,000 with only $10 as capital. However, you should know that the risks of loss are also higher when using leverage.
- Flexible trading strategies. The implementation of trading strategies works much better with crypto futures than trading actual cryptocurrencies, especially when it comes to intra-day trading. Also, crypto futures allow you to go short without any blockers. Hence, there are more rooms for you to deploy different trading strategies to maximize profits.
- No funding rate: One important diffference between futures compared to perpetutal futures is that futures do not have a funding rate, and prices are often in contango, meaning future prices are higher than the current spot prices. This creates an opportunity known as cash and carry arbitrage, which is a market-neutral strategy that combines a long position in the spot market and a short position in futures. On the day of the settlement the futures price converges with the spot market price, generating relatively riskless returns regardless of the market condition or volatility.
Risks of Futures Trading
Generally speaking, some experts believe that the underlying crypto market is not mature enough for a futures market to exist. Such critics claim that instability in Bitcoin might spread to other parts of the futures market. However, so far, no significant incidents have been reported by crypto futures platforms, as most of them are not prone to hacking attacks, unlike regular crypto exchanges that store clients’ crypto holdings. For example, trading futures on Bybit is smooth and convenient.
Still, there are risks related to market volatility, a 24/7 market, poor futures trading strategies adopted from traditional markets without any adjustments, and higher-than-recommended leverage, which is appealing for beginners.
What to Consider Before Trading Futures?
Futures trading is not entirely the same as regular trading, despite the similarities. Here are several key aspects you should take into account:
Leverage is the crucial feature of margin trading, which is offered by most futures trading platforms today. By using leverage, traders can boost potential profits, but the risks are parallel to the leverage it involves. Though typically crypto exchanges offer up to 50x leverage, Bybit offers up to 100x leverage for their perpetual contracts, while Binance offers up to 125x leverage. Trading with high leverage may be potential gains for advanced traders, but it is still risky for the position to be liquidated.
When trading futures, beginners should avoid betting on high leverage, but a minimal leverage level may do the trick. The selected leverage decides the margin required for trading. For example, if a trader opts for 10x leverage, the position will have 10% of his funds, and the rest is borrowed. It’s either from the exchange itself or from traders who are lending upon interest.
Traders and investors look closely into a new asset’s liquidity to determine market integrity, transaction speed, market fluidity, and generally, to assess an asset’s stability— all in which to allow traders to exchange their asset for cash quickly without too much price slippage.
When trading futures, there are three main metrics to determine liquidity. It includes asset, exchange, and market liquidity. A trader should always consider if there are enough buyers, sellers, makers and takers, and the overall state of an asset and market.
Generally, most futures crypto markets’ liquidity is higher than on spot exchanges, as most futures contracts are in cash settlement. Thus, there is no need for Bitcoin at all, except in Bitcoin futures with physical delivery. Thanks to sufficient liquidity, the risk of price slippage is much lower. But the fundamentals should always be carried out to mitigate risks.
Trading crypto futures is an excellent method to hedge against traditional assets or against the possibility of a sharp decline in the cryptocurrency itself. Institutional investors would prefer Bitcoin futures as a hedging tool. Trading Bitcoin futures don’t expose you to the extreme BTC price losses in the spot market, given that the futures contract has a predetermined price for the expiry date.
Besides hedging, crypto futures allow you to diversify your capital. It is no secret that diversification is one of the best money management techniques available to traders and investors. You can open multiple positions in Bitcoin(BTC), Ethereum(ETH), Chainlink (LINK), and many other tokens to create a well-diversified portfolio made up of futures contracts. In this way, you can mitigate the risk of being exposed to a single asset that can unexpectedly decline in price.
One of the most important things to know about trading cryptocurrencies and their respective futures is the high volatility. While this is mostly presented as a risk, it also comes with more opportunities. That is especially for short-term traders who prefer to speculate on the quick price movements. Cryptocurrencies still represent a small market compared to forex or stocks. So, digital assets are prone to wild fluctuations influenced by whales or various events affecting the industry.
Suppose you trade regular cryptocurrency futures settled in cash. In that case, you should pay attention to the expiration date because this is when you will receive your cash or stablecoin funds upon settlement of the contract. Nevertheless, you can sell your open futures contract at any point before the expiration date. And thus, record profit or loss depending on the change in the spot price.
How to Trade Crypto Futures?
Trading cryptocurrency futures is no different from other trading forms, and the difficulty level depends on the leverage you pick. You should follow most of the valid rules when trading the spot markets or other derivatives, be it CFDs or options. Most of the rules have to do with risk management and finding the best entry and exit points.
Here are the main steps to successfully start your crypto futures trading journey:
- Set aside some funds – one of the most critical risk management recommendations is you should never invest more than you are ready to lose. And never borrow to trade unless we’re speaking about the technical borrowing used in margin trading.
- Dedicate time – you shouldn’t treat your crypto futures trading as a hobby if you plan to turn it into a lucrative activity. Make sure to dedicate time to learn futures trading, find the right entry points, and monitor your open positions.
- Trade on a demo account – you can start trading with virtual funds on a demo account. It usually mimics the spot price of Bitcoin or any other cryptocurrency before going to futures. Try to trade on Bybit’s demo account for free here.
- Choose a futures trading platform – reputation is a key when selecting a crypto exchange. So, if you are a beginner, start trading on a reputable exchange, and you should always start small.
Trading perpetual contracts will require you to automatically pay a rate or get paid. But, depending on whether the contract’s price is higher or lower than the spot price. Also, if you use leverage, you should check the position margin, which is fluctuating with the price. If it drops below a certain threshold, your position will be liquidated, and you will incur a loss.
Who Should Trade Futures?
Everyone interested in cryptocurrency trading might start by trading futures. This financial instrument is especially suitable for those who want to get exposure to cryptocurrency. But, without actually holding it in digital wallets and bothering about its security.
How Profitable Is Crypto Futures Trading?
Crypto futures trading can be very profitable if proper risk management is implemented. For regular traders, this activity can be more profitable than Bitcoin mining, given that the latter requires expensive equipment. However, this is the best-case scenario. As with any form of trading, there are considerable risks that should not be ignored.
The Final Note
Both institutional and retail traders prefer cryptocurrency futures thanks to their convenience and lower risk of hacking attacks than the spot market.
Crypto futures are still more popular than crypto options, which represent another type of derivatives. In an option contract, the buyer of the option has the right but not the obligation to buy the underlying asset in the case of a call option or sell it in the case of a put option at a predetermined price within a certain period.
Both derivatives enable traders to hedge against volatility risk and experience new trading forms that can end up more profitable than regular trading.