The Basics of the Murky Waters of Cryptocurrency Futures and What You Can Do to Get Your Feet Wet in this New Land of Opportunity
It was a bit surprising recently when I came to learn that many fairly well-seasoned investors, with a wide array of risk experience in cryptocurrency markets, are not extremely knowledgeable when it comes to cryptocurrency futures and other similar financial products now available to investors. After writing about the basics of cryptocurrencies (please see the article, Is Cryptocurrency Like Bitcoin Worth a Look?, by David Rounick) recently, it is only a natural progression to put cryptocurrency futures as the next topic in line, as the discussion continues. Gaining knowledge of crypto futures may be profitable for some investors while also offering stability and protection for others. Let’s begin with the basics of what exactly a cryptocurrency future is, by definition, and then continue on to discuss the topic in greater detail.
Futures (also referred to as “future contracts”) in simple terms, are not as complex as you may think and basically a standardized agreement between two parties that are both trading on the same market. This standardized agreement is nothing more than one party agreeing to sell a specific number of items (such as a specific commodity or financial instrument – for example, the US dollar) for a set price while promising to deliver at that predetermined price at a specified time in the future, to the buyer. These futures contracts are then able to be “traded” in the futures markets, which allow for a standardized method to buy and sell these contracts.
Although that is a simple description of what futures contracts are and how they work, often it is easier to understand what they are and how they work, based on who is buying them and why. Futures contracts are often traded by two key types of players – speculators and hedgers. Let’s take a look at the “hedger” first. This is a person or entity that is looking to “hedge” their position related to a specific commodity, product or financial instrument by locking in the price at which that specific commodity is sold or purchased, at some point in the future. This allows them to buy a “guarantee” at some point in the future for that commodity and this may allow them to minimize a specific risk related to their position as it relates to either that specific commodity or how that commodity affects another asset they own.
While portfolio managers or traders may also make a bet on the price movements of an underlying asset using futures. The main reason that companies or individuals use future contracts is to offset their risk and exposure from any fluctuations in the price of a commodity (often, the commodity being a currency). The ultimate goal of an investor using futures contracts to hedge is to ideally offset as close to 100% of their risk, as possible.
Alternatively, speculating in futures is done by investors looking to profit only on their transactions. The futures markets are open, and relatively liquid, nearly 24 hours per day. This allows traders to buy and sell nearly 24/7. Speculating in futures comes with a high degree of risk and is best left to experienced investors.
Now that you may be a little more familiar with futures, let’s dig a bit deeper into cryptocurrency futures. Whether you are simply looking for new trading opportunities because you like the thrill of it (and want to take advantage of the significant price fluctuations in crypto), or a capital-efficient means by which to manage your overall portfolio risk, futures offer a wide array of products to accomplish either of these objectives, and are definitely worth taking a closer look at. If you want to get started quickly, you need to start learning everything possible about the specific cryptocurrency that you are most interested in, and then researching it thoroughly. Also, getting familiar with the past performance will also help you get a feel for how volatile these cryptocurrencies have been in the past. What you are trying to do is focusing on trying to get a solid feel for what has affected the currency’s value in the past and what may affect it down the road – while also, getting comfortable with what forces are responsible for price changes moving forward. After you get a feel for what is happening “in the game” for that cryptocurrency, then you can take the next steps and get your feet wet in the futures markets.
Prior to cryptocurrencies such as Bitcoin having futures, they were extremely volatile. While there are also still some questions as to whether these cryptocurrencies will survive years from now. In the meantime, those questions will not stop many from trading cryptocurrencies.
Like trading options, keep in mind the component of time when it comes to trading futures. That can take some experience getting used to, if new to futures. Whether you take a dip into trading Bitcoin or other cryptocurrencies such as Ethereal, Litecoin, Ripple or others — do your due diligence and always know that with futures you can lose even more than your original investment.
After you get some experience dealing with futures in the cryptocurrency marketplace and gain confidence, you can also consider looking into options on futures and the myriad of other products available through the different cryptocurrency exchanges.
Please keep in mind that while I often share my thoughts and experiences online related to different investments — I am in no way trying to provide any investment advice – simply defining and explaining how these financial instruments work. Always consider the inherent volatility that comes with cryptocurrency investments and any type of investing – and seek professional assistance whenever possible.
Keep checking back on davidrounick.com as I will always try to continue the cryptocurrency discussions for those interested.