Bitcoin Futures vs Conventional Futures Contracts: Core Differences Crypto Investors Should Know
With the advent of cryptocurrency, investors have now been presented with a lot of new unique financial opportunities to explore. In this regard, we need to learn about crypto-based futures contracts and how they differ from traditional futures contracts. So without any further ado, let's get to the meat of it.
So What Exactly is a Futures Contract and How Do They Work?
Simply put, a futures contract can be thought of as a pre-defined agreement that is made between two parties that have mutually agreed to buy or sell a particular currency, financial commodity at a pre-established price (as well as a set-time in the future).
When talking about futures trading, it is important to understand that all of the parties involved in such an agreement have certain rights and obligations that have already been put-forth within the stipulated contract. As a result of this:
“The buyer is obligated to procure the underlying asset when the futures contract reaches its expiration date. In turn, the seller of the futures contract is obligated to provide the underlying asset at the expiration date.”
Additionally, it is also worth mentioning that OKCoin was the first ever trading platform to offer enthusiasts with the possibility of trading crypto futures contracts.
Why Futures Contracts?
The primary goal of making use of a futures contracts is to “protect investors from the risk of constant price fluctuations” (since the leverage on offer differs for each separate product).
Also worth mentioning is the fact that the ‘leverage’ in question is established by making use of ‘Initial Margin and Maintenance Margin levels’. What this basically means is that to enter and maintain positions, investors are required to hold a minimum amount of a specific equity.
The Similarities Between Crypto and Traditional Futures Contracts
To begin with, we need to understand that both crypto and traditional futures options are established upon an underlying asset. So for example, a Bitcoin future will always be linked to the trading price of Bitcoin— a principle that will apply to any other futures option as well ( be it a stock option, currency etc).
However, with that being said, it is difficult to determine the value of a futures contract for more niche cryptocurrencies (especially when compared to oil, gold).
Other points of similarities include:
- Both crypto and traditional futures make use of a concept called ‘leverage’, which means that investors have no obligation to “own the entire amount of capital” to take on a particular position. As a result of this, capital efficacy can be heightened which in turn allows traders to take on bigger positions.
- Both crypto and traditional futures provide investors with a certain degree of risk mitigation.
What Are the Main Differences?
The core differences between the two offerings stem from the fact that cryptocurrencies have only been around for a couple of years. As a result of this, there is very less historical price data which traders can use while making their predictions.
Not only that, even correlating prices and using other macroeconomic indicators becomes difficult when talking about cryptocurrencies.
Other points to consider:
- Volatility: When looking at the economic shape of the global cryptocurrency sector, we can see that these markets have faced immense volatility within the past year alone (especially when compared to traditional fiat markets). Even though the reasons for this volatility may be varied, it should be noted that nascent markets usually have a tendency to be more prone to fluctuations.
- Collateral: Another core difference lies in the fact that nearly all traditional futures make use of fiat, hard or financial assets as collateral. However, in the case of crypto, investors first need to convert their holdings into fiat, then post them as collateral.
More on the Matter
Recently, various crypto exchanges have also begun accepting different alt-coins as collateral. However, due to the constant price swings associated with crypto, traders who post collateral have the responsibility to react to various “unanticipated margin calls” swiftly.
Lastly, it is also worth remembering, that ‘market volatility’ strengthens the use for futures in an investment portfolio. What this means is that when established properly, these contracts can “help keep the value of crypto assets protected from market frictions.”
Considering how nascent cryptocurrency futures are when compared to their traditional counterparts, investors in this burgeoning domain have “fewer resources” to implement in terms of their trading strategies. This, however, does not imply that crypto futures trading is more difficult or easy (it simply means that investors have to be more vigilant when taking on this financial avenue).