The Pros and Cons of Bitcoin Futures Trading
Posted On June 26, 2023
Bitcoin futures trading is a form of derivative contract that allows investors to speculate on the future price of bitcoin without actually owning the underlying asset. Bitcoin futures trading has become increasingly popular in recent years, as it offers some advantages over spot trading, such as leverage, hedging, and price discovery. However, bitcoin futures trading also comes with some drawbacks, such as high fees, liquidity risks, and regulatory uncertainty.
In this blog post, we will explore the pros and cons of bitcoin futures trading and provide some tips on how to get started.
Pros of Bitcoin Futures Trading
One of the main benefits of bitcoin futures trading is that it allows investors to leverage their positions and amplify their returns. Leverage is the ratio of the amount of money borrowed to the amount of money invested. For example, if an investor uses 10x leverage, they can open a position worth $10,000 with only $1,000 of their own funds. This means that if the price of bitcoin moves in their favor by 10%, they can make a profit of $1,000, or 100% of their initial investment. However, leverage also works both ways, so if the price moves against them by 10%, they can lose $1,000, or 100% of their initial investment.
Another benefit of bitcoin futures trading is that it allows investors to hedge their exposure to the volatility of bitcoin. Hedging is a strategy that involves taking an opposite position to an existing one in order to reduce the risk of loss. For example, if an investor owns 10 bitcoins and expects the price to drop in the near future, they can sell 10 bitcoin futures contracts and lock in their current price. This way, if the price of bitcoin falls, they can offset their losses from their spot position with their gains from their futures position. Conversely, if the price of bitcoin rises, they can offset their losses from their futures position with their gains from their spot position.
A third benefit of bitcoin futures trading is that it facilitates price discovery and market efficiency. Price discovery is the process by which buyers and sellers determine the fair value of an asset based on supply and demand. Market efficiency is the degree to which the prices of assets reflect all available information and expectations. Bitcoin futures trading helps to improve price discovery and market efficiency by providing more information and liquidity to the market. By aggregating the opinions and expectations of various participants, bitcoin futures trading helps to establish a consensus price for bitcoin that reflects its true value. Moreover, by allowing more traders to enter and exit the market quickly and easily, bitcoin futures trading helps to reduce price discrepancies and arbitrage opportunities.
Cons of Bitcoin Futures Trading
One of the main drawbacks of bitcoin futures trading is that it involves high fees and commissions that can eat into the profits of traders. Fees and commissions are the charges that traders have to pay to brokers, exchanges, and clearing houses for executing and settling their trades. Fees and commissions vary depending on the platform, contract type, contract size, leverage level, and trading volume. For example, according to CME Group’s website (as of June 10th 2023), the fees for trading one bitcoin futures contract (worth 5 bitcoins) are $5 per side per contract for non-members and $1 per side per contract for members. Additionally, there are clearing fees ($0.02 per side per contract), exchange fees ($0.01 per side per contract), NFA fees ($0.02 per side per contract), and data fees ($5 per month). These fees can add up quickly and reduce the net returns of traders.
Another drawback of bitcoin futures trading is that it exposes traders to liquidity risks and slippage. Liquidity risk is the risk that traders may not be able to buy or sell their contracts at their desired price or quantity due to a lack of market participants or orders. Slippage is the difference between the expected price of a trade and the actual price at which it is executed. Liquidity risk and slippage are more likely to occur during periods of high volatility or low volume when there are large price movements or gaps in the market. For example, on May 19th 2021 (known as Black Wednesday), the price of bitcoin dropped by more than 30% in a matter of hours due to a cascade of liquidations triggered by margin calls. Many traders who were holding long positions in bitcoin futures contracts were unable to close them at their desired prices or had to pay hefty premiums to do so.
A third drawback of bitcoin futures trading is that it faces regulatory uncertainty and legal challenges in some jurisdictions. Regulatory uncertainty is the lack of clarity or consistency regarding the rules and regulations governing an activity or industry. Legal challenges are the disputes or lawsuits that arise from the interpretation or enforcement of the rules and regulations. Bitcoin futures trading is subject to different regulatory frameworks and legal systems depending on the country, state, or region where it is conducted. For example, in the US, bitcoin futures trading is regulated by the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), which have different definitions and classifications of bitcoin and other cryptocurrencies. In some countries, such as China, India, and Iran, bitcoin futures trading is banned or restricted due to concerns over financial stability, capital flight, money laundering, and sanctions evasion.
How to Get Started with Bitcoin Futures Trading
If you are interested in bitcoin futures trading, here are some steps you can take to get started:
- Choose a reputable and regulated platform that offers bitcoin futures trading. Some of the most popular platforms include CME Group, Bakkt, Kraken Futures, BitMEX, OKEx, Huobi, and Binance. Make sure to compare the features, fees, contract specifications, security measures, customer support, and reputation of each platform before making a decision.
- Open an account and verify your identity and address. Depending on the platform and your location, you may need to provide some personal information and documents to comply with the anti-money laundering (AML) and know-your-customer (KYC) requirements. You may also need to pass a suitability test to prove your knowledge and experience in futures trading.
- Fund your account with fiat currency or cryptocurrency. Depending on the platform and your preference, you may be able to deposit US dollars, euros, or other fiat currencies via bank transfer, credit card, or wire transfer. Alternatively, you may be able to deposit bitcoin or other cryptocurrencies via a wallet address or QR code.
- Choose a contract type and size. Depending on the platform and your strategy, you may be able to trade cash-settled or physically-settled contracts, monthly or quarterly contracts, inverse or quanto contracts, perpetual or fixed-term contracts, etc. You may also be able to choose the contract size (e.g., 1 bitcoin or 5 bitcoins) and the leverage level (e.g., 2x or 100x).
- Place an order and execute your trade. Depending on the platform and your preference, you may be able to place different types of orders, such as market orders, limit orders, stop orders, take profit orders, etc. You may also be able to use different types of order execution modes, such as immediate-or-cancel (IOC), fill-or-kill (FOK), good-til-canceled (GTC), etc.
- Monitor your position and manage your risk. Depending on the platform and your strategy, you may need to monitor your position regularly and adjust it according to the market conditions and your expectations. You may also need to manage your risk by using stop-loss orders, margin calls, liquidation prices, etc.
Bitcoin futures trading is a form of derivative contract that allows investors to speculate on the future price of bitcoin without actually owning the underlying asset. Bitcoin futures trading has some advantages over spot trading, such as leverage, hedging, and price discovery. However, bitcoin futures trading also has some drawbacks, such as high fees, liquidity risks, and regulatory uncertainty. If you are interested in bitcoin futures trading, you should do your research and choose a reputable and regulated platform that suits your needs and preferences. You should also be aware of the risks involved and use proper risk management techniques to protect your capital.