At the end of 2017, derivatives trading for bitcoin arrived in the US. The debut of futures and options trading was widely considered to be a milestone for the development of the cryptocurrency industry. Read on to learn everything you need to know about how futures work and where to go to get started trading them.
The Benefits of Trading Bitcoin Derivatives
Lets you trade with more money than you actually have
The main benefit of using futures, options and other derivatives is leveraged trading. Leverage allows you to borrow money for trades. This means that you can potentially multiply your gains. The flip side to this, of course, is that any losses you take will be multiplied as well.
You don’t need to buy actual bitcoins
The fact that bitcoin contracts aren’t actual bitcoins means that you don’t have to worry about the security issues around storing your bitcoin assets. If a hacker gains unauthorized access to a bitcoin wallet and sends the funds somewhere, there’s no way to get those funds back.
It takes time for a cryptocurrency networks to process a transaction. Those transactions can be particularly slow and costly when the network is busy. By contrast, derivative contracts are processed immediately.
Param Vir Singh, professor of business technologies for the Tepper School of Business at Carnegie Mellon University, provided this summary of cryptocurrency shortcomings to CNBC:
“Bitcoin prices are volatile; the transaction speed is slow; the bitcoin trading platform is illiquid.”
A $10,000 purchase on a bitcoin exchange typically results in fees ranging anywhere from $10 to $100 or more, depending on the exchange. A long-term investor that opted to use futures to invest in bitcoin instead would only have to pay around 50 cents in fees. Some brokerages that support futures trading for bitcoin even offer commission-free trading. These brokerages can afford to offer zero percent commissions because they make their money by charging interest for margin loans.
High cost of entry
Some futures brokers require large initial deposits. TD Ameritrade requires a $25,000 minimum deposit, for example. In addition, if a futures contract starts losing money, an exchange may require the investor to add additional funds to maintain the position.
Steep learning curve
Cryptocurrency trading platforms that support futures and options are much more technical compared to beginner-oriented crypto exchanges. It takes a significant amount of time and effort to decipher the terminology and understand the interfaces.
Futures vs. Options: What’s the Difference?
One of the main differences between bitcoin futures and bitcoin options boils down to the cost of getting started. Investors that want to open a bitcoin options contract have to pay an up-front premium. This premium ensures that the issuer of the options contract can recover a portion of money in the event that the underlying asset drops in value.
If you open a futures contract, you won’t pay a premium. You will, however, have to put more money on the line. Futures contracts require a larger minimum investment compared to options contracts.
Generally, futures trading is considered to be more risky than options trading. More detailed information about the difference between futures and options is available via Investopedia.
A Quick Bitcoin Futures Tutorial
One easy way to learn the ropes of trading is through the use of a sandbox trading environment. The BitMEX exchange has an excellent trading sandbox, which is available here. This short tutorial will walk you through the basics of trading futures on BitMEX.
Step 1: Create your account
After you create a free account on BitMEX’s testnet, you’ll receive a small deposit of pretend money to invest. Just click the Register button and follow the instructions to get started.
Step 2: Select a futures contract
BitMEX allows traders to open ten different types of futures contracts. In addition to standard Bitcoin contracts, other options include Bitcoin / Yen, Cardano, Bitcoin Cash, EOS Token, Ethereum, Litecoin, Tron, Ripple and Bitcoin / Won.
The image embedded below indicates that the current bitcoin contract is set to Perpetual. This means that payments are exchanged every eight hours and that the contracts you buy never expire.
Because the rate is currently positive, investors with long positions will pay investors with short positions at the end of the eight hour period. Likewise, if the position was negative, then the shorts would pay the longs.
(100x) means that you can borrow up to 100 times the amount of money in your account. Since the test account gives you 0.01 BTC to play with, you can invest an entire bitcoin in a position if you opt to max out your leverage.
Every contract is worth about 1 dollars’ worth of bitcoin.
Step 3: Initiate an order
The Place Order box on the left side of the interface enables you to initiate an order. If you’re learning how to trade, you may want to place a market order instead of a limit order. Market orders get processed faster compared to limit orders. Click the Market tab to make the change.
Next, type the amount of contracts you want to buy in the Quantity box. Finally, you can adjust the amount of money that you want to borrow by using the slider tool.
Once you’ve completed all that, it’s time to stake out a position. If you think the price of bitcoin will go up, click Buy Market. If you believe that prices will go down, click Sell Market.
Step 4: Confirm the order
The Confirm Your Order box lets you adjust the margin slider before you send your order out to the exchange. Order Value indicates the total value of your order and Cost @ 25x shows how much you actually paid for it. Available Balance indicates how much money you currently have in your account.
Step 5: Track your position
Now that you have a position, you can track it on the bottom part of the interface. Because the price of bitcoin jumped up after I put in my sell order, this particular contract would result in a loss if I closed it out now.
Step 6: Experiment with different trading strategies
The best way to learn how to trade derivatives to experiment on your own. Use a variety of different sandbox exchanges until you begin to earn a profit. Once you understand all the terms and try out all the features, you’ll have all the knowledge you need to sign up with a trading platform that supports bitcoin futures trading.
Where to Trade
Here’s a list of exchanges that are available in the US and support bitcoin futures. If you know of any brokers that aren’t on the list, please let us know in the comment section below.
Hong-Kong-based BitMEX, also known as the Bitcoin Mercantile Exchange, offers Bitcoin futures trading with up to 100x leverage. BitMEX brands itself as offering “The Next Generation of Bitcoin Trading Products,” and was founded by Arthur Hayes, a former Citigroup and Deutsche Bank trader.
CBOE was the first exchange to introduce bitcoin futures in the United States. On the exchange’s official website, Cboe promotes itself as an expert in the area of financial product development:
“In designing XBT futures, Cboe leveraged its significant product development expertise to design an instrument that allows participants to implement trading strategies in a manner to which they are accustomed. The single price settlement process gives participants the option of using XBT futures to hedge their exposure in underlying bitcoin or gain exposure to traded bitcoin prices without holding bitcoin.”
TDAmeritrade also offers bitcoin futures trading. The Omaha-based brokerage firm claims that it has developed a “premier derivatives trading platform for serious traders.” Other benefits include 24/7 customer service and straightforward pricing.
CME Group describes itself as “the leading and largest derivatives marketplace.” Advantages of trading with CEM Group include 24/7 trading access, diversified price sources, deep market liquidity and clearing services provided through CEM Clearing.
Advantage Futures bills itself as “one of the highest volume futures clearing firms in the industry.” It provides bitcoin futures trading through CBOE and CME Group. More details are available here.
ED&F Man Capital Markets is a registered futures commission merchant and the world’s largest hedge fund company. Brooks Dudley, Vice President of ED&F Man Capital Markets, issued the following statement shortly after it launched support for bitcoin futures trading:
“Every day we facilitate EFPs for our clients in physical assets such as soybeans, wheat and treasuries. EFPs on CME Bitcoin futures mark an important step forward in the maturity of the regulated derivatives market for digital currencies.”
Interactive Brokers promises to deliver competitive commissions and “the best financial deal without the hassle of having to transfer between accounts.” Its customers can deposit their paychecks directly and use their funds for investment purposes.
New York-based brokerage firm Etrade offers 24 hours a day / six days a week trading, minimal short selling restrictions, flexible trading limits and professional trading tools. It launched bitcoin futures trading through CME in early 2018.
Straits Financial offers “state-of-the-art trading platforms” and “all the protections and transparency of The Chicago Board of Options Exchange and The Chicago Mercantile Exchange.”
Benefits of trading with online broker TradeStation include simplified low commission pricing, reduced intraday margin rates and its new interest sharing program. More details are available here.