How Bitcoin Futures Trading Works: Principles, Advantages and Disadvantages

What Are Futures?

Futures are standardized contracts between two parties to buy or sell a specific asset at a predetermined price on a specific future date and time. Typically, futures contracts are traded on futures exchanges. These contracts specify the quality, quantity, and price of the underlying asset. There are several reasons why parties enter into futures contracts. First, since the agreement involves trading at a specific price at a future point in time, the buyer of the underlying asset can be protected against price fluctuations in the market. Because both parties have committed to buying or selling at a designated price, the contract holder may realize profits or, in some cases, incur losses.

Unlike most financial contracts that grant the holder the right to do something, futures contracts impose both the 'right' and 'obligation' on both parties to fulfill the terms of the contract. Generally, futures contracts require physical delivery of the underlying asset, while another type of futures contract is cash-settled. This fundamental distinction shapes how different market participants utilize these instruments for hedging or speculation purposes.

How Do Futures Contracts Work?

Futures contracts involve two parties: a buyer and a seller, who can lock in costs and trade before recovering the asset. This mechanism provides price certainty in volatile markets and enables strategic planning for both commercial and investment purposes.

Assets used in futures contracts on futures exchanges include various commodities and financial instruments. To better understand this, let's assume a farmer wants to sell a large quantity of corn in the next harvest season. Although the corn has not yet been produced, the farmer wants to secure an appropriate price for the future. The farmer then finds a buyer willing to pay the current market price or a similar price. In this case, the seller and buyer can enter into a futures contract at a specific price. This protects both the seller and buyer from significant price fluctuations, providing financial stability and predictability.

Futures contracts typically involve two main types of traders: hedgers and speculators. Hedgers are interested in the underlying asset and want to hedge against price fluctuation risks, while speculators do not actually use the assets fixed in futures contracts. Instead, speculators buy futures and later sell them to stakeholders for profit. This dual-participant structure creates market liquidity and price discovery mechanisms.

In futures contracts, you can enter either a long or short position. A long position means one party promises to buy the asset at a specific date and time, while a short position means promising to sell the asset at a specific date and price. These positions allow traders to profit from both rising and falling markets.

What Are Bitcoin Futures?

Like traditional futures contracts, Bitcoin can also be traded through futures contracts. This innovation has brought institutional legitimacy to the cryptocurrency market and provided new avenues for price speculation and risk management.

Simply put, Bitcoin futures are contracts where two parties agree to buy or sell Bitcoin at a specific future price and date. In late 2017, major financial institutions introduced Bitcoin futures contracts. Contracts traded on electronic trading platforms are cash-settled. Bitcoin futures are based on established Bitcoin reference rates that aggregate pricing data from multiple sources.

Bitcoin futures trading does not involve actual Bitcoin. Since futures are cash-settled contracts, Bitcoin itself is not involved in the transaction. Like other futures contracts, investors simply predict Bitcoin's price without actually buying or selling the underlying cryptocurrency asset. However, if Bitcoin's price is expected to rise, you can take a long (buy) position, or if you hold Bitcoin, you can take a short position to reduce potential losses. This flexibility makes Bitcoin futures an attractive tool for portfolio management and risk mitigation.

It's important to note that the price of Bitcoin futures contracts is proportional to the Bitcoin price. Therefore, Bitcoin futures trading is an alternative to spot trading, which involves actually buying or selling the underlying cryptocurrency asset. While spot trading offers direct ownership and the ability to use the cryptocurrency, futures trading provides leverage opportunities and the ability to profit in both bull and bear markets.

Spot trading only offers basic trading orders such as buying low and selling high, and tends to profit during market uptrends. On the other hand, Bitcoin futures trading allows you to trade and leverage profits in both bull and bear markets, providing greater strategic flexibility for experienced traders.

Types of Bitcoin Futures

Currently, there are several types in the Bitcoin futures market, and different platforms offer various derivative trading options. The most common products are standard futures contracts and perpetual swap contracts. These two products are popular derivatives commonly traded in today's investment industry. However, these two products have different characteristics, so they must be clearly understood before investing.

Futures Contracts vs Perpetual Swap Contracts

The essential differences between Bitcoin perpetual swap contracts and Bitcoin futures contracts are as follows:

Bitcoin perpetual swaps have no expiration date set in the contract. They are essentially infinite and endless. On the other hand, Bitcoin futures contracts have an agreed-upon expiration date. Therefore, there is a period during which the contract must be honored, typically at least one month or longer. This structural difference fundamentally affects trading strategies and risk management approaches.

Since perpetual swaps have no expiration date, exchanges use a price synchronization system called the funding rate mechanism. This mechanism stabilizes short and long positions in perpetual swaps by adding or subtracting trades. It requires fees that help maintain the short and long positions in perpetual contracts, ensuring that contract prices remain anchored to spot market prices.

Another characteristic of perpetual swaps is that they generally reflect spot market trends, which can be attractive to cryptocurrency traders. However, volatility is a major risk here. Consequently, perpetual swap contract prices tend to deviate from spot prices when market volatility is high. This deviation creates both opportunities and risks for traders who must carefully monitor funding rates and market conditions.

Similar to Bitcoin futures, perpetual swaps are a trading method that does not require continuously resetting long and short positions. This is achieved through coin swaps between traders, ensuring that the price of perpetual swaps matches the spot price. Unlike Bitcoin futures, perpetual swaps have no expiration date, so there is no need for an automatic price adjustment process related to contract terms and related assets. This allows traders to trade more flexibly without continuously renewing contracts, making perpetual swaps particularly popular among active traders.

How Do Bitcoin Futures Work?

The operating principle of Bitcoin futures is the same as that of traditional futures contracts. Additionally, trading through centralized exchanges can help avoid large-scale risks by providing regulatory oversight, liquidity guarantees, and standardized contract terms.

To better understand this, let's assume you purchase Bitcoin with a $40,000 futures contract to be settled in two months. According to the futures contract, if it trades at $50,000 in two months, you will gain a profit of $10,000 per contract. However, if it falls to $30,000 by then, you will incur a loss of $10,000 per position. This simple example illustrates both the profit potential and the inherent risks of futures trading.

If you think the price will fall, you can sell a futures contract at $40,000 under the same conditions. This means that even if Bitcoin falls to $30,000 by the expiration date, you can sell at $40,000, earning a profit of $10,000. At this time, Bitcoin must be above $40,000 at expiration for a short position to be profitable. This short-selling capability is one of the key advantages of futures trading over spot trading.

To fulfill these obligations, we deposit money called 'margin'. Margin refers to the minimum collateral that must be held in the account to execute a trade. The more money you put into a trade, the higher the margin required by the exchange to complete the trade. This margin system protects both traders and exchanges from excessive losses.

Generally, margin ranges from 5% to 15% of the underlying asset's value. This relatively low margin requirement enables significant leverage, which amplifies both potential gains and potential losses.

Leverage

The higher the leverage, the more exposure you have to high returns or losses. Additionally, the amount you can trade depends on the amount of available margin. For example, major exchanges offer leverage of up to 125 times the trading amount. Leverage determines the volatility level of a trade. While high leverage can multiply profits, it can also lead to rapid liquidation if the market moves against your position. Therefore, understanding and managing leverage is crucial for successful futures trading.

Advantages and Disadvantages of Bitcoin Futures

Bitcoin futures trading has many advantages and disadvantages. For experienced traders, it is a major source of cryptocurrency profits, but it comes with several risks that must be carefully considered.

These factors highlight the importance of education, risk management, and strategic planning when engaging in Bitcoin futures trading. Beginners should start with small positions and gradually increase their exposure as they gain experience and understanding.

Relationship Between Bitcoin Futures and Bitcoin Price

Bitcoin futures contracts are agreements to buy or sell Bitcoin at a set price on a future date. While the price of these contracts is expected to move in line with Bitcoin's actual market price, various factors during the contract period can cause differences from the actual price. This can influence the current price of Bitcoin, causing it to rise or fall. Understanding this relationship is crucial for both futures traders and spot market participants.

This typically causes sharp volatility. For example, when large corporations like major tech companies invest more heavily in Bitcoin, or when major countries implement cryptocurrency trading restrictions. Supply and demand issues for Bitcoin prices can widen or narrow the spread of Bitcoin futures contracts. These events create arbitrage opportunities and can lead to significant price movements in both futures and spot markets.

Another price fluctuation is known as a gap. This is a period when no trading occurs, and there is no price data during this time. Unlike the broader cryptocurrency market that trades 24/7, traditional platforms have specific trading hours, which can only be traded on platforms like major regulated exchanges. These gaps can create opportunities for gap trading strategies but also introduce additional risks for position holders.

Where Can You Trade Bitcoin Futures

You can trade Bitcoin futures on various platforms, whether they are regulated exchanges or centralized cryptocurrency exchanges. The following exchanges are available:

• Chicago Board Options Exchange (CBOE): CBOE was the first US-based exchange to offer Bitcoin futures contracts. It began offering products on December 10, 2017. A week later, the Chicago Mercantile Exchange followed suit, marking a significant milestone in cryptocurrency market maturation.
• Chicago Mercantile Exchange (CME): Another platform where you can trade Bitcoin futures. It implements the Bitcoin Reference Rate, which is the volume-weighted average price of Bitcoin supplied from multiple exchanges, usually calculated daily between 3 PM and 4 PM. CME's Bitcoin futures contracts trade from 5 PM to 4 PM (Central Time) from Sunday to Friday and expire on the last Friday of each month. This regulated environment provides institutional-grade infrastructure and risk management.

Korean Cryptocurrency Exchanges

• Major Korean Platforms: Several centralized exchanges in Korea offer Bitcoin futures trading with user-friendly interfaces and support for various cryptocurrencies. These platforms provide both spot and futures trading services, featuring easy-to-use platforms and high liquidity. Korean exchanges are known for their robust security measures and regulatory compliance.

International Cryptocurrency Exchanges

• Leading Global Platforms: Several mainstream exchanges offer futures trading with attractive features including high leverage options. Users can access leverage ranging from 50x to 100x depending on the asset. These platforms provide advanced trading tools, API access, and comprehensive risk management features.
• Other platforms include various established exchanges that offer competitive trading conditions and diverse cryptocurrency futures products.

When selecting an exchange, consider factors such as regulatory compliance, security measures, trading fees, available leverage, and user interface quality.

Is Bitcoin Futures Trading a Good Choice?

There are many ways to start investing in Bitcoin, and currently, there is no perfect investment method. Bitcoin futures are a good way to make money, but at the same time, you can also suffer significant financial losses. Therefore, you should thoroughly understand the advantages and risks of Bitcoin and choose the strategy that best suits you.

Successful Bitcoin futures trading requires a combination of market knowledge, technical analysis skills, risk management discipline, and emotional control. Beginners should start with paper trading or small positions, gradually building experience before committing significant capital. It's also essential to stay informed about market developments, regulatory changes, and macroeconomic factors that can influence Bitcoin prices.

Ultimately, whether Bitcoin futures trading is a good choice depends on your individual circumstances, including your risk tolerance, investment goals, trading experience, and available capital. Careful consideration of these factors, combined with ongoing education and disciplined risk management, can help determine if Bitcoin futures trading aligns with your investment strategy.

FAQ

What is the difference between Bitcoin futures and spot trading?

Bitcoin futures have fixed trading hours and price limits, while spot trading operates 24/7 with no restrictions. Futures involve contracts expiring at specific dates, whereas spot trading involves immediate asset delivery. Futures allow leverage trading, enabling higher potential returns with less capital.

What are the main advantages of Bitcoin futures trading?

Bitcoin futures offer low trading fees, high liquidity, and allow traders to profit without holding actual Bitcoin. They provide effective risk hedging opportunities and leverage for amplified returns.

What are the risks and disadvantages of Bitcoin futures trading?

Bitcoin futures trading carries significant risks including extreme price volatility, high leverage amplifying losses, liquidation threats, and market manipulation. Limited regulatory oversight and technical glitches pose additional dangers. Inexperienced traders face substantial financial exposure.

How to start Bitcoin futures trading? What conditions are needed?

Choose a reliable futures platform, register and verify your account, meet minimum capital requirements, and implement proper risk management. Select appropriate leverage and trading strategies based on your experience level and market analysis.

What is leverage trading? How is it used in Bitcoin futures?

Leverage trading amplifies your trading position by borrowing funds, allowing you to control larger Bitcoin futures positions with smaller capital. For example, 10x leverage lets you control a $10,000 position with just $1,000, multiplying both potential gains and losses accordingly.

What are the contract types for Bitcoin futures (Perpetual Contracts vs Term Contracts)?

Bitcoin futures include two main types: term contracts with fixed expiration dates, and perpetual contracts without expiration dates. Term contracts settle at predetermined times, while perpetual contracts allow indefinite holding with funding rates.

How to manage risks in Bitcoin futures trading (stop-loss, position sizing)?

Set strict stop-loss orders to limit losses. Start with small positions and avoid excessive leverage. Maintain proper position sizing—typically risk only 1-2% of capital per trade. Regularly review and adjust your strategy based on market conditions.

What are the main Bitcoin futures trading platforms?

Major Bitcoin futures trading platforms include CME, Binance Futures, Bybit, Deribit, and OKX. These platforms offer various leverage options, liquidity, and trading features tailored to different trader needs and risk preferences.

Why do Bitcoin futures prices differ from spot prices?

Bitcoin futures and spot prices differ due to market supply-demand dynamics, leverage effects, and trading volume variations. Futures markets are more sensitive to leveraged trading activity, causing price divergence from actual spot markets.