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What are bitcoin futures? How do they work?

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Bitcoin (BTC) has seen a meteoric rise in popularity over the past decade. Yet, many investors remain skeptical of the cryptocurrency market due to its decentralized nature, questionable security, unclear regulations, and extreme volatility.

Despite these drawbacks, Bitcoin took a big step towards legitimacy in October 2017 when CME Group, the world’s leading derivatives exchange, launched Bitcoin futures trading.

Four years later, ProShares again made history by launching a futures-based Bitcoin ETF, the first-ever crypto exchange-traded fund to gain regulatory approval to trade on a major US exchange.

Bitcoin futures offer investors a unique way to speculate in the crypto market and hedge their crypto holdings. But before you dive into crypto futures, we’ll help you understand how they work and the risks involved.

What are bitcoin futures?

Futures contracts are a type of derivative contract that obligates two parties to exchange an asset – or a cash equivalent – at a predetermined price on a future date.

When investors buy and sell Bitcoin futures, they are speculating on the future price of BTC. Essentially, two parties are making a bet: one believes that the price of BTC will rise in the future, and another is betting that the price of BTC will fall. The wrong person pays the other party a cash settlement.

There are various futures contracts, for currencies, stock indices and commodities. The Commodity Futures Trading Commission (CTFC) regulates the entire futures market and the agency considers bitcoin to be a commodity, so bitcoin futures are commodity futures.

Bitcoin futures trade on the Chicago Mercantile Exchange (CME), which introduces new monthly contracts for cash settlement.

The CME offers monthly BTC futures contracts for six months and additional quarterly contracts for each of the next four quarters. CME Group is also offering an additional December deal if only one is listed.

Each futures contract represents 5 BTC. Monthly futures contracts expire on the last Friday of each month.

First Month Bitcoin Futures

Short-term Bitcoin futures contracts are the contracts with the earliest expiry date. They are also called first month futures.

First-month futures typically trade closest to the spot price of Bitcoin, and they can trade above or below the spot price, depending on whether the market believes Bitcoin prices will rise or fall. short term.

The price of Bitcoin traded on crypto exchanges is considered the spot price of BTC.

First-month futures usually trade at a price above the current spot price, a condition known as contango. Contango represents market expectations that asset prices will rise in the near term.

Meanwhile, the backwardation indicates that the market expects asset prices to decline soon.

How to Trade Bitcoin Futures

Since each bitcoin futures contract represents 5 BTC, there is inherent leverage in the bitcoin futures market.

Bitcoin futures traders often use this leverage to speculate on short-term market fluctuations with the aim of generating large returns on relatively small initial investments.

At the same time, futures contracts can also be an effective way to mitigate risk. An investor with a large bitcoin investment can sell a small number of bitcoin futures contracts to buy an insurance policy against a bitcoin market crash.

Bobby Ong, chief investment officer and co-founder of CoinGecko, says Bitcoin futures can be useful for both short-term and long-term investors.

“Due to the volatile nature of Bitcoin and cryptocurrencies in general, short-term traders can use Bitcoin futures to capture outsized gains during short bursts of heightened volatility,” Ong says.

Long-term investors can also benefit from using Bitcoin futures for speculative or hedging purposes.

Bitcoin ETFs and Futures

The Securities and Exchange Commission (SEC) and other regulators have been extremely cautious in their approach to Bitcoin and other cryptocurrencies.

The SEC has yet to approve a Bitcoin spot ETF that invests directly in cryptocurrency to list on a major US exchange.

Nonetheless, the SEC made history in 2021 when it approved the first Bitcoin futures ETF, the ProShares Bitcoin Strategy ETF (BITO), to trade on the New York Stock Exchange.

Instead of investing in bitcoin directly, the BITO fund and other bitcoin futures ETFs invest in a diverse basket of bitcoin futures.

Erik Anderson, senior digital asset research analyst at Global X ETFs, says crypto futures ETFs have a few advantages.

“U.S.-listed Bitcoin future ETFs provide investors with regulatory protections that do not exist on crypto-native exchanges and bring the benefits of direct integration into traditional brokerage accounts, such as those used in harvesting tax losses,” Anderson said.

Are Bitcoin Futures a good investment?

Much like the cryptocurrency market itself, there are several pros and cons for investors when it comes to Bitcoin futures. Futures contracts can provide investors with flexibility, leverage, and the ability to mitigate risk through hedging.

But leverage can be a double-edged sword for investors, and futures losses can add up quickly if the market takes a turn for the worse.

Additionally, Bitcoin futures traders are subject to margin calls which can trigger the forced liquidation of their positions at the worst possible time if they cannot maintain minimum margin requirements on their accounts. Bitcoin futures traders are also subject to exchange fees, which can affect trading profits.

Ryan Cullen, CEO of Cullen Cioffi Capital Management, says Bitcoin futures can be a useful tool for crypto traders. Nevertheless, it is essential that traders fully understand and manage the risks involved.

“Because Bitcoin is quite volatile and futures contracts allow you to take a larger position, you can take advantage of short-term market fluctuations,” he says.

But he warns investors that the Bitcoin futures market is highly speculative. “Futures contracts allow you to exert considerable leverage, which means that you can end up with an oversized position that ends up being worth very little or nothing.”

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