With the year-long bear market that crippled the crypto markets, many traders in search of profit are asking themselves how do Bitcoin futures work? These contracts have found their place in the cryptocurrency markets but many traders still don’t fully understand how they work nor do they know about Bitcoin futures expiration dates or margin and what these mean. Futures also lead to the creation of a brand new type of contracts specific to cryptocurrencies, the Bitcoin perpetual contracts.
Q: How do Bitcoin futures work?
A: Bitcoin futures work as an agreement between two parties to buy or sell Bitcoin at a given date in the future at a pre-determined price. A long position would agree to buy Bitcoins in the future at the pre-determined price, while short position would inversely agree to sell Bitcoins at the pre-determined price. Traders then make a profit or a loss depending on the price of the asset during the contract.
An example would be two traders open a BTCUSD futures contract with different directions. The price of Bitcoin is at $3,800 when they open the contract. Trader A goes long, trader B goes short, and both buy one Bitcoin’s worth. After a month the price has dropped to 3,200, trader A has lost $600 as he now has to buy a Bitcoin at $3,800 while the price is lower, while trader B makes $600 as he now sells a Bitcoin at $3,8000 while the price is at 3,200.
Bitcoin futures contract then work by allowing traders to speculate, or “bet”, on the future price of Bitcoin but without having to actually own a Bitcoin.
But what stops traders from holding on indefinitely to their futures contracts in wait of the price changing to the direction they wanted? Well, that’s where Futures expiration dates and margin come in.
Q: What is Bitcoin futures expiration dates?
A: As previously mentioned, Bitcoin futures have an expiration date at which the contract must be brought to an end, or pay a settlement, by either selling or buying Bitcoin irrespective of the price. This means that traders need to be careful of not only the market price but also the contract’s date as they might otherwise wake up with a very nasty surprise and see their contract end at a bad time for them.
Q: What is Bitcoin futures margin?
A: Bitcoin Futures trading is part of the margin trading business through the use of derivatives. A Futures contract has two types of margin, namely initial margin and maintenance margin. The initial margin is the value of what a trader used to trade compared to the contract’s value, as leverage allows for traders to only use a portion of the contract’s value.
Any price differences are prioritarily taken from the initial margin, meaning that a drop of $20 in price would be taken from the initial margin. The maintenance margin is the minimum margin required to keep a position. If the margin touches or goes under the maintenance margin, the position is forcefully liquidated.
Q: What is a perpetual contract?
A: Bitcoin perpetual contracts resemble Bitcoin futures in that they allow traders to speculate on the future price of Bitcoin by entering long or short positions, but contrary to futures they have no expiry date.
The expiry date mechanism has been replaced by a funding mechanism in which a trader needs to pay the opposing position a small percentage of their position at regular intervals. The paying or receiving position depends on the difference between the last traded price on the exchange and the index price.
As opposed to futures, perpetual contracts allow traders to hold onto their position for as long as they want and maximize their profits.
This concludes today’s article about how do Bitcoin futures work, we hope you enjoyed the read, learned a lot about Bitcoin futures and perpetual contracts and stay tuned for more great content.