The US Commodity Futures Trading Commission (CFTC) gave the final approval necessary for Bitcoin to be classified as a legitimate alternative investment for both institutional and retail investors. Bitcoin futures have opened Bitcoin up to a larger investor pool because now there is another way to invest in Bitcoin without having to get a wallet.
What are Futures?
Futures are financial derivatives. A future is a contract sold to investors. The futures contract holder is bound to the agreement to buy or sell an underlying asset at a fixed price on or before an established future date. Futures trading has been traditionally done with commodities like crude oil and gold.
So to illustrate how this works, let’s say you are going to need to buy a lot of crude oil because you have a private jet fleet that you’re planning on flying around the world later that year.
It’s January, and you believe the price of oil is going to go up in the next three months from its current rate of $100 a barrel. So you can buy a futures contract to have the right to purchase 10 barrels of crude oil at $100 on or before March 31st for a total of ($1000).
It’s now March and like you predicted oil is now $200 a barrel, so your new contract value is ($2000).
You can close your contract out by either getting your profit of $1000 in fiat currency or have the oil delivered to your fleet at the agreed purchase price.
The advantage of a futures contract is the contract holder didn’t have to actually buy the ten barrels of oil in January to benefit from the rise in price. Just the cost of the contract was the only capital required in January to make a bet on this oil position.
Futures contracts have the following characteristics:
- Traded on exchanges
- List the quantity of the asset
Futures contracts can be redeemed in 2 ways:
- Fiat currency
- A physical delivery of the asset listed on the contract
What Do Futures Mean for Bitcoin?
Bitcoin futures allow investors to speculate on the price of bitcoin without having to go through the trouble of getting a bitcoin wallet to store their position. This feature of not having to hold Bitcoin dramatically reduces one of the critical risks of investing in digital currencies, namely, safe storage.
As Bitcoin futures are exchange-traded, they could become very liquid investment vehicles over time. More liquidity will draw in more institutional investors to participate in cryptocurrency. So far, liquidity in bitcoin futures has been lower in comparison to other commodities, but it is still relatively early on for Bitcoin futures.
Additionally, through the use of futures contracts, investors can now bet on the price of bitcoin declining by selling futures. This new ability to sell futures allows all the bitcoin “bears” to put their money where their mouth is and short Bitcoin.
You can turn a profit if the price declines, but your exposure to loss is unlimited. The price can only fall so much, but the price can rise theoretically without any limit. If you have a future contract for sale, you have to cover the losses if the price of Bitcoin rises.
The ability to sell futures gives you the ability to hedge against the crash of Bitcoin. Let’s say you own 5 Bitcoins and then you sell a futures contract that predicts it will crash in value. If Bitcoin has an exponential rise, you will be covered with what you own. If it crashes, you can profit off of the futures contract.
This futures contract helps reduce the risk of your overall position. The ability to have “insurance” on an investment position lowers the overall risk of the investment. This reduced risk will attract more institutional money into the Bitcoin space and give them exposure to cryptocurrency.
Bitcoin futures are a financially regulated product. Regulations are attractive to large institutional investors because they are bound by tight fiduciary regulations when trading their clients assets.
This new introduction of having some rules instead of being the wild west opens Bitcoin up to a much larger investment community. Before Bitcoin futures, the influx of fiat currency was limited to only retail investors and high net worth individuals.
So if even if only 30% of the total institutional money goes into the cryptocurrency market, it will have a massive impact on its liquidity and overall value. Overall the introduction of futures into the market is great for the long-term value of Bitcoin.
We’ll be sharing more posts like these on cryptocurrency as we launch https://www.formosa.financial/ an institutional grade custodial service for high net worth traders, businesses and their complex needs.