What to know about bitcoin futures

Cboe Global Markets' bitcoin futures product launches Sunday. The product will allow investors to bet on the coin's future price and could open.
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Sunday's launch of Cboe Global Markets ' bitcoin futures were just the opening act. When CME Group launches its bitcoin futures contract on the largest futures exchange in the world on December 18, it'll be a very big deal for the futures markets, brokerage firms, and of course, bitcoin. Here's everything you need to know about how these futures will work, and which brokers will actually let you trade bitcoin futures in your brokerage account. If we're being frank with one another, futures are just a socially accepted and legal!

We can spare the financial jargon. I'll explain how futures work with an illustrative example where you and a coworker bet on the future price of bitcoin. Here goes. You think it will be worth more in the future. Your friend Bob thinks it will be worth less. Annoyed with your endless tirades about bitcoin, Bob tells you to put your money where your mouth is, drawing up a bet based on bitcoin's price three months from today.

Risks with Bitcoin Futures

If bitcoin goes up, Bob will pay you an amount equal to its gains. If it goes down, you'll pay Bob for how much it drops. You're "long" bitcoin, and thus you make money if it goes up. Bob's "short" bitcoin, and thus he makes money if it goes down. Three months pass, and it's time to settle the bet. And just like that, Bob and you have basically made your own little futures market without even knowing it. Futures really are that simple.

Bitcoin futures are about to go live, and they could change the game for cryptocurrencies

You can think of futures contracts as nothing more than a side bet between two people with opposing views. Bitcoin contracts are settled in cash, with the "loser" paying the "winner" his or her profits. You don't have to own bitcoin.


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You don't have to buy bitcoin on a sketchy online exchange. No bitcoin even changes hands during any of the process. You just have to find someone else to take the other side of a bet. The futures market makes finding someone to take the other side of your wager as easy as clicking a button.

Will bitcoin “shorts” crash the price of bitcoin?

Unlike many financial markets, futures are a zero-sum game. For every person who is long bitcoin, someone else must take the opposite side and be short bitcoin. For someone to make a dollar in futures, someone else must necessarily lose a dollar. It's basically online gambling, legal in all 50 states, and best of all, money you make in the futures market is generally treated better by the Internal Revenue Service IRS than money you make betting on college basketball.


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Speculators love futures because they allow for the use of leverage to multiply their gains or losses when prices rise or fall. Note: Your broker may have different -- higher -- margin requirements. Source: Hypothetical example designed by author. Margin requirements sourced from CME Group. From a speculator's standpoint, leverage is a key feature of the futures market.

It may help to think about this in percentage terms. CME Group's bitcoin futures will likely trade at a value that approximates the current market price of the cryptocurrency on online exchanges multiplied by five. The price index is updated every minute on the CME Group website , where it writes that the index is "suitable for marking portfolios, executing intraday bitcoin transactions and risk management. When it comes to the official settlement -- the name for the time at which gains or losses are officially tallied -- CME will use a different index it calls the Bitcoin Reference Rate BRR to determine the official value for its futures contracts.

One of the most basic problems standing in the way of cryptocurrency-based investment vehicles is that online bitcoin exchanges aren't very deep. The Bitcoin Reference Rate is designed to make this kind of market manipulation more difficult, even if not entirely impossible. In simple terms, the Bitcoin Reference Rate is a price for bitcoin based on the "average" bitcoin price on multiple exchanges over the course of an hour. Manipulating the price of bitcoin for a single second or minute is relatively easy. Doing it for an hour would be very hard to do.

If you're especially curious about the official methodology used to calculate the Bitcoin Reference Rate, I explain it in the paragraph below. Otherwise, scroll on to the next header in the article. London time a. The trades that occur during this hour are segmented into 12 time intervals of five minutes each. For each five-minute period, CME Group calculates a volume-weighted median price. The 12 median prices from each five-minute period are then averaged, resulting in the Bitcoin Reference Rate used to value bitcoin futures at settlement.

This is the situation that occurred shortly after the launch of Bitcoin Futures in late As the latter example shows, it takes an experienced investor to leverage futures properly. Critically, you will need to have a firm understanding of the market cycles and fluctuations if you intend to make a profit trading futures.

That being said, there are some undeniable benefits Bitcoin Futures introduce to the sector. In the case of Bitcoin Futures, the advantages are too great to ignore. For one, Bitcoin Futures trade on regulated exchanges. Importantly, these platforms receive regulation directly from the Commodity Futures Trading Commission. Regulated exchanges are more secure than their crypto alternatives. In the past, investors incurred major losses after the collapse of unregulated crypto exchanges. In one now-infamous instance, the largest crypto exchange at the time, Mt.

Gox, collapsed after a hack left the exchange in financial ruins.

[] Liquidation, Leverage and Optimal Margin in Bitcoin Futures Markets

Sadly, the collapsed exchange cost investors millions. Worst of all, investors had no recourse because the platform was unregulated. Another major advantage of Bitcoin Futures is that they settle in cash. This makes sense once you realize that no actual Bitcoin trading occurred.

Related Securities

In fact, the investor and the exchange never own any Bitcoin during the transaction. Rather, an agreement to trade Bitcoin in the future at a set price trades. Another advantage Bitcoin Futures bring to the market is the ability to short. Shorting is an investment strategy where an investor enters into a trade with the goal to profit from a drop in the market value of an underlying asset. Because Futures pricing updates daily, investors can short futures by repurchasing their contract at a lower price. Keenly, you can continue to repurchase your futures contract at a lower and lower price as the market drops.

In this way, investors can see huge profits during times of market losses. One of the most attractive attributes about trading futures is that you only need to put a percentage of the contracts total down to trade. Importantly, this strategy allows investors to leverage their position to maximize profits. In essence, investors gain unlimited profit potential.

Reversely, there is unlimited loss potential as well. Notably, it took years before Bitcoin Futures appeared on US regulated exchanges. However, the excitement was short-lived. While many speculated the price drop was due to scalability issues within the Bitcoin network, the Federal Reserve Bank of San Francisco suggested that Bitcoin futures were one of the main contributors to the drop. The reasoning behind this allegation is the introduction of shorts to the market. Bitcoin Futures are set to play a critical role in the market moving forward.

As such, they continue to be at the forefront of any cryptocurrency discussion.