Leave behind about the sort-of bitcoin ETF Bitcoin Investment Trust (NASDAQOTH: GBTC) . Futures could become the newest and best way to bet on bitcoin.
Sunday’s launch of Cboe Global Markets‘ bitcoin futures were just the opening act. When CME Group launches its bitcoin futures contract on the largest futures exchange ter the world on December Eighteen, it’ll be a very big overeenkomst for the futures markets, brokerage firms, and of course, bitcoin.
Here’s everything you need to know about how thesis futures will work, and which brokers will actually let you trade bitcoin futures ter your brokerage account.
1. How futures work
If wij’re being open with one another, futures are just a socially accepted (and legal!) way to gamble on the future price of all kinds of things — corn, utility stocks, rente rates, the S&P 500, and now, bitcoin. Wij can spare the financial vaktaal. I’ll explain how futures work with an illustrative example where you and a coworker bet on the future price of bitcoin. Here goes.
One bitcoin presently trades for $16,000. You think it will be worth more ter the future. Your friend Bob thinks it will be worth less. Annoyed with your endless tirades about bitcoin, Bob tells you to waterput your money where your mouth is, drawing up a bet based on bitcoin’s price three months from today.
If bitcoin goes up, Bob will pay you an amount equal to its gains. If it goes down, you’ll pay Bob for how much it drops. You’re “long” bitcoin, and thus you make money if it goes up. Bob’s “brief” bitcoin, and thus he makes money if it goes down.
Three months pass, and it’s time to lodge the bet. You and Bob loom online and see that bitcoin is trading for $Legal,000. You won the bet, and Bob pays you $Two,000, or the difference inbetween the current price ($Legal,000) and the price at which you commenced the wager ($16,000). And just like that, Bob and you have basically made your own little futures market without even knowing it. Futures truly are that plain.
You can think of futures contracts spil nothing more than a side bet inbetween two people with opposing views. Bitcoin contracts are lodged ter metselspecie, with the “loser” paying the “winner” his or hier profits.
You don’t have to own bitcoin. You don’t have to buy bitcoin on a sketchy online exchange. No bitcoin even switches arms during any of the process. You just have to find someone else to take the other side of a bet. The futures market makes finding someone to take the other side of your wager spil effortless spil clicking a button.
Unlike many financial markets, futures are a zero-sum spel. For every person who is long bitcoin, someone else voorwaarde take the opposite side and be brief bitcoin. For someone to make a dollar ter futures, someone else voorwaarde necessarily lose a dollar. It’s basically online gambling, legal te all 50 states, and best of all, money you make te the futures market is generally treated better by the Internal Revenue Service (IRS) than money you make betting on collegium basketball.
Two. Bitcoin futures are leveraged
Speculators love futures because they permit for the use of leverage to multiply their gains or losses when prices rise or fall.
The CME Group anticipates that its bitcoin futures will be subject to a margin requirement of 43%, meaning you only have to waterput up 43% of the value of the underlying bitcoin to buy or sell a futures contract. (Note: Your broker may have different — higher — margin requirements.)
Spil I write this, one bitcoin trades for approximately $16,000. A hypothetical CME bitcoin futures contract would have a notional value of about $80,000 (five bitcoin vanaf contract multiplied by the market price of $16,000). Therefore, investors would only have to pony up about $34,400 of their own money to profit on the build up or loss on five bitcoin worth $80,000.
Bitcoin vanaf Futures Contract
Notional Value of Bitcoin
Initial Margin Requirement
Source: Hypothetical example designed by author. Margin requirements sourced from CME Group.
From a speculator’s standpoint, leverage is a key feature of the futures market. With $34,400 of metselspecie, you could afford to buy a little overheen two bitcoin on a bitcoin exchange. However, through the futures market, $34,400 would enable you to profit on the ups and downs of five bitcoin.
It may help to think about this ter percentage terms. If you only pony up 43% of the value of the underlying bitcoin, every 1 percentage-point switch te the price of bitcoin would result te a Two.33 percentage-point build up or loss on the margin you waterput up to open the trade. (100/43 =
Three. How bitcoin futures will trade
CME Group’s bitcoin futures will likely trade at a value that approximates the current market price of the cryptocurrency on online exchanges multiplied by five. CME Group has its own Bitcoin Real Time Index (BRTI) to use spil a guide for what bitcoin are worth at any given time.
The price index is updated every minute on the CME Group webstek, where it writes that the index is “suitable for marking portfolios, executing intraday bitcoin transactions and risk management.” Simply said, CME’s bitcoin futures should trade for toughly five times the current Bitcoin Real Time Index, spil calculated by CME.
When it comes to the official settlement — the name for the time at which gains or losses are officially tallied — CME will use a different index it calls the Bitcoin Reference Rate (BRR) to determine the official value for its futures contracts.
One of the most basic problems standing te the way of cryptocurrency-based investment vehicles is that online bitcoin exchanges aren’t very deep. Te theory, a market manipulator could accumulate a supersized, $Ten million futures bet that bitcoin will rise ter value. Just before the contract lodges, the market manipulator could rush to an online bitcoin exchange and buy $Two million of bitcoin, pushing up the price. He might lose 2%-3% on the $Two million buy due to fees and filthy trading, but it’s worth losing 2%-3% on $Two million if it nets a 2%-3% build up on a $Ten million futures position.
The Bitcoin Reference Rate is designed to make this zuigeling of market manipulation more difficult, even if not entirely unlikely. Ter plain terms, the Bitcoin Reference Rate is a price for bitcoin based on the “average” bitcoin price on numerous exchanges overheen the course of an hour. Manipulating the price of bitcoin for a single 2nd or minute is relatively effortless. Doing it for an hour would be very hard to do.
If you’re especially nosey about the official methodology used to calculate the Bitcoin Reference Rate, I explain it te the paragraph below. Otherwise, scroll on to the next header ter the article.
Source: Getty Pics.
The actual methodology used to calculate the Bitcoin Reference Rate is spil goes after: Trades on bitcoin exchanges Bitstamp, GDAX, itBit, and Openleggen are logged from Three:00 p.m. to Four:00 p.m. London time (Ten:00 a.m. to 11 a.m. EST). The trades that occur during this hour are segmented into 12 time intervals of five minutes each. For each five-minute period, CME Group calculates a volume-weighted median price.
The 12 median prices from each five-minute period are then averaged, resulting ter the Bitcoin Reference Rate used to value bitcoin futures at settlement. All this is relatively unimportant when the futures are actively trading, since during those times (most of the day), prices are more likely to go after the simpler Bitcoin Real Time Index.
Four. CME Group’s bitcoin futures will likely eclipse Cboe’s
Cboe made a lotsbestemming of noise when it launched its bitcoin futures contracts. So far, tho’, trading volume has bot relatively light. Launched on Sunday, only Four,127 Cboe contracts traded palms by the end of trading on Monday.
Cboe isn’t a big player ter futures. You might surmise that from its name, which is derived from “Chicago Houtvezelplaat Options Exchange.” Options, not futures, are Cboe Global Markets’ bread and butter. Ter tegenstelling, the CME is generally regarded spil the futures exchange, spil it is the largest te the world. Some brokers, like Ally Invest, have even specifically said they’re waiting on the sidelines for the CME Group contracts to launch, passing on the Cboe’s contracts.
I suspect the CME’s bitcoin contracts will be far more popular with investors for the elementary reason that they’re more likely to be supported by more brokers. Te addition, commissions on CME’s futures may be lower spil a percentage of notional value than Cboe’s. CME Group’s futures contracts represent ownership of five bitcoin, whereas Cboe’s futures represent ownership of one bitcoin, an significant difference since commissions are often priced on a per-contract fundament.
If you dreamed to get exposure to 50 bitcoin through Interactive Brokers (NASDAQ: IBKR) , the only broker to publish a price list for both futures contracts, you’d have to trade 50 Cboe contracts and pay a commission of $Five vanaf contract, or $250 te total. To get the same exposure with CME bitcoin futures, you’d only have to trade Ten contracts, paying $Ten vanaf contract ter commissions, or $100 ter total.
Five. Will your broker offerande bitcoin futures?
Most brokers aren’t ready to bring bitcoin futures to their clients, but it’s expected that more brokers will hop on the bitcoin train overheen time.
Interactive Brokers has already opened up Cboe bitcoin futures for trading and will permit its clients to dabble ter CME Group’s bitcoin futures, too. For now, you can only go long bitcoin futures, but the discount broker announced it will soon enable its clients to brief bitcoin futures.
TD Ameritrade and Ally Invest (formerly TradeKing) have indicated their rente te rolling out futures to their customers, tho’ details are sparse, and timelines are unknown. More than 40% of trades placed on TD Ameritrade are for financial derivatives like futures, so it seems like a natural getraind for adding bitcoin futures relatively quickly.
Charles Schwab and E*TRADE may add the products, but only after watching how the market develops. By all reports, Fidelity isn’t interested ter bitcoin futures, which is interesting considering that the sort-of bitcoin ETF, Bitcoin Investment Trust, often emerges spil one of the most actively traded stocks on its verhoging. If you want to trade bitcoin futures right now, Interactive Brokers is the only spel ter town.
Blame bitcoin’s volatility for brokers’ hesitation. Futures are inherently risky for brokerages because speculators who use leverage can lose all of their account balance and more if the market goes against them. When that happens, brokerages have to become debt collectors, and what they can’t collect from their money-losing clients they have to eat spil a loss.
The CME Group has thresholds on how much a futures contract can budge on any one day. A 7% stir may result te a two-minute trading halt. It stringently forbids trading at any prices 20% higher or lower than where the contract opened for the day.
Of course, CME Group only has power overheen its exchanges. Bitcoin can trade loosely on online exchanges where there aren’t any real rules to govern price fluctuations. I count 27 times te which bitcoin traded 20% above or below the opening price, using gegevens from CoinMarketCap.com going back to May 2013.
On its best day te the gegevens set, bitcoin rocketed by 42%. On its worst day, it plunged by 38%. Brokerages are clever to tread cautiously. Speculators should tread cautiously, too.