Crypto Future: What Are They, How They Work and Who Can Operate Them?
A crypto future is a contract that promises to buy or sell a certain amount of cryptocurrency in the future at a price agreed upon by both parties.
The cryptocurrency market is growing rapidly, benefiting from investors and the arrival of new investment instruments such as a crypto future contract.
Futures have proven to be a powerful trading instrument since their inception. Primarily because they offer a lot of flexibility and the ability to protect the investments of those who use them.
Characteristics Of a Crypto Future Contract
When we talk about the crypto future market, we are talking about a market where a contract between parties obliges them to buy or sell a certain financial asset in the future in accordance with the terms of that contract.
A crypto future specifies certain data, such as trading volume, price, and validity period. After the due date, payment must be made in accordance with the terms of the contract.
They are a type of derivative trading contract, so these instruments can be found in both regulated and unregulated markets, such as over-the-counter (OTC) markets.
Although the futures market is centuries old, it is still used to take advantage of good trades between parties. Especially when exogenous conditions and circumstances drive price volatility, as in cryptocurrency markets.
The Origin of The Futures Market
The origins of the current futures or futures market go back to the famous system of protection of agricultural producers of the XIX century, the so-called «forward».
Thanks to this system, producers can sell their products during a high harvest period, regulate and stabilize prices, promote the sale of their products, and maintain market prices.
However, its operation began in the 18th century, more precisely, in the city of Osaka in Japan in 1730. At that time, the Tokugawa shogunate, which ruled the eastern side of the country for more than a century, ordered the creation of an infrastructure stable market for future rice deliveries.
This economic infrastructure allowed feudal lords to sell the rice they collected from their land taxes to intermediaries through auctions and futures coupons awarded to the highest bidder.
Furthermore, all these activities are documented in the Book of Dojima, which marks the beginning of the first futures market: the famous Dojima Rice Market.
The price of rice set at the Dojima Rice Market was communicated to the capital and other large cities within a radius of hundreds of kilometers through messengers and notice boards . In addition, many of the trading rules and practices developed by Dojima were later used on the financial, stock, and commodity futures exchanges.
This tool was later used to create the first modern futures market, which began trading on the Chicago Grain Exchange in 1848. At that time, ground rules for the trading and contractual operations of the commodity futures market began to be established.
How Does a Futures Contract Work?
To better understand how futures markets work, it’s best to create an example scenario:
Imagine that you want to buy 10,000 tons of rice from the producer at a price of EUR 450 per ton. For the purchase, he has decided to enter into a forward contract for an amount of 4,500,000 euros, which expires in August 2024. This means that in August 2024 he will be able to obtain the rice he bought and will be able to sell it or use it as he wishes. At this point, two situations can occur:
1- The price of a ton of rice has increased to 550 euros due to the greater demand for rice and the lower production volume.
2- The price of a ton of rice has dropped to 380 euros due to low demand or abundant production.
In the first case, if the price goes up, your futures contract will be a positive contract because you bought 10,000 tons of rice at a price below the market price (you bought it at €450 a ton, not €550 a ton) and you will have a benefit of 1,000,000 euros. Instead, in the second case, it causes a loss because you have bought at a price higher than the current market value.
Of course, the terms of the futures contract can be defined differently depending on the needs of both parties to the transaction, always betting on the best terms. However, once these terms are provided and the contract is finalized, they will apply to both parties in their entirety.
Now that we know what futures are and how they work, it’s time to understand their characteristics, among which we can mention:
They are regulated markets with well-defined activities. So, there is a legal framework that protects both parties.
Who Can Participate in The Futures Market?
Anyone can participate in this market, which is essential for them because it provides liquidity. Furthermore, these participants can be grouped as follows:
- Market participants: They are banks, investment companies, brokerage houses, financial intermediaries, and official intermediaries.
- Arbitration or professional clients: Those who use the market to protect their investments and shares and take advantage of the price distortions of different assets listed on the markets at the same time.
- Hedger: A participant who tries to hedge against changes in the price of a product for the sole purpose of minimizing losses that may occur at various stages of the sale of the product. These will be: producers, exporters, cooperatives, etc. They often use the futures market to hedge various risks.
- Individual or private clients, also known as speculators or investors: these are players who buy or sell futures contracts based on bullish or bearish expectations, and try to take advantage of price fluctuations.
The Characteristics of The Crypto Future Market: Regulation and Leverage
The futures market is regulated by the clearing house. This entity acts as a mediator in the negotiations of the operation and seeks that the terms of the negotiations are respected and that they operate in accordance with the standard contract.
Also, the futures market is a very transparent market. This is because market prices and rates are published daily. Futures markets are available for a variety of real assets (commodities) and other assets of great interest to investors.
Futures markets offer a high level of leverage, which ultimately has a multiplier effect on future profits or losses. At this point, the trader must weigh the pros and cons, especially since they can cause significant losses when the market is unknown.
When having a clear understanding of the stock market and the concept of a crypto future, it seems that the most convenient and fastest way to trade is futures. Also, transparency, volatility, and leverage make futures trading a good opportunity to trade.
Although there are companies and exchanges such as Bakkt, CME or CBOE that offer regulated crypto future contracts, most of the crypto future contracts are unregulated. This is due to the legal vacuum in the world of cryptocurrencies. Of course, this does not prevent it from being a stable and reliable futures market; they are decentralized and the trust between the parties to the stipulated contract is reduced. However, if your primary concern is participating in a regulated market, please consider this information and familiarize yourself with the platform before making any investment.
Pros And Cons of a Crypto Future Contract
The main advantages of investing in a crypto future contract are:
- Initial costs: A crypto future tends to have lower costs than other financial instruments.
- Liquidity: It is a financial product that provides liquidity.
- Insolvency risk: Clearing houses guarantee the settlement of contracts.
- Flexibility in negotiations: the contract can be concluded at any time before the deadline.
Among the disadvantages we can mention:
- Market: There are no futures that cover all cash positions.
- Expiration Date: The market determines the expiration date.
- Risks: This is a high risk product. It is possible to lose the entire investment.
- Advance Deposit: This type of financial product requires a security deposit that covers multiple risks.
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