Many merchants coming into cryptocurrency markets from conventional finance could look to derivatives as autos for worth hypothesis and hedging. There are many decisions with regards to exchanges and devices; nonetheless, merchants ought to contemplate a number of key variations between crypto futures and conventional futures earlier than dipping a toe into this quickly rising market.
Totally different devices
Merchants coming into cryptocurrency from the normal markets will likely be accustomed to futures contracts with a hard and fast expiration date. Though fastened expiration contracts might be present in cryptocurrency markets, a major proportion of crypto futures buying and selling is in perpetual contracts, also called perpetual swaps. This variation of a futures contract doesn’t have a hard and fast finish date, which means the dealer can maintain an open place indefinitely.
Exchanges that provide perpetual contracts use a mechanism generally known as “funding fee” to periodically steadiness the worth variances between the contract markets and the spot costs. If the funding fee is constructive, the perpetual contract worth is larger than the spot fee — longs pay shorts. Conversely, a damaging funding fee implies that shorts pay longs.
Furthermore, merchants that come to cryptocurrency from conventional finance could also be used to the portability of their positions throughout totally different exchanges. In distinction, cryptocurrency exchanges typically function as walled gardens, which means it’s unimaginable to switch derivatives contracts throughout platforms.
Regulated vs. unregulated buying and selling platforms
A lot of the buying and selling in cryptocurrency futures — round 85 to 90% — is but to be regulated. This case primarily arose as a result of cryptocurrency futures markets sprang up whereas regulators had been nonetheless grappling with extra elementary questions across the authorized standing of digital property. BitMEX paved the best way for cryptocurrency futures buying and selling through the use of coin-margined and collateralized contracts. In doing so, the corporate prevented the regulatory necessities related to fiat on-ramps. There are round a dozen main buying and selling platforms at the moment, however solely a small variety of them have achieved regulated standing.
Each the Chicago Mercantile Exchange (CME) and Bakkt are regulated by the USA Commodity Futures Buying and selling Fee (CFTC). In Europe, Kraken Futures operates under a multilateral trading facility license awarded by the UK Monetary Conduct Authority. In Switzerland, Vontobel and Leonteq offer mini-Bitcoin futures contracts by way of the SIX Swiss Alternate.
The regulatory scenario could preclude merchants in some nations from taking part in buying and selling on non-regulated venues. This circumstance is especially true of the U.S., the place exchanges are conscious that the CFTC is now pursuing BitMEX for violating Anti-Cash Laundering laws and the Financial institution Secrecy Act.
Nevertheless, the U.S.-regulated crypto futures platforms have expanded their vary of devices past pure Bitcoin (BTC) futures, seemingly in response to growing demand. The CME, for instance, not too long ago branched out beyond Bitcoin futures and choices to supply Ether (ETH) futures too. As well as, Bakkt additionally affords Bitcoin month-to-month futures and choices.
Unregulated platforms provide futures contracts and perpetual swaps in opposition to a broader vary of altcoins, though solely to merchants in nations the place they’re permitted to function. In any case, most liquidity stays concentrated in BTC and ETH futures, at the very least for now.
Differing regulatory landscapes, mixed with how perpetual contracts are managed, end in some sensible variations between crypto futures and conventional futures. As there isn’t a central counterparty clearing system, exchanges expose themselves to a excessive diploma of danger, significantly provided that many provide excessive leverages of as much as 125 occasions. Due to this fact, shedding positions that attain the upkeep margin will likely be liquidated.
Exchanges sometimes divert any earnings from liquidations into an insurance coverage fund, which exists to guard merchants’ earnings when their counterparty doesn’t have ample margin to cowl the commerce. The presence and relative well being of an insurance coverage fund is a vital consideration when utilizing an unregulated alternate. With no fund, or if the fund turns into too low to cowl the losses incurred by liquidations, worthwhile merchants tackle the danger of getting their positions “auto-deleveraged” by the alternate.
One other vital operational consideration is alternate downtime. Lots of the unregulated platforms have a status for servers crashing during periods of high volatility, leading to merchants being unable to shut their positions earlier than being liquidated. Due to this fact, it’s value researching a platform’s historical past of downtime earlier than opening an account.
Low obstacles to entry
The cryptocurrency futures markets typically have a really low barrier to entry. A dealer can open an account, endure the “know your buyer” course of, deposit funds, and begin buying and selling inside a matter of minutes.
In distinction, the obstacles to entry for exchange-traded futures are excessive as a result of contract sizes concerned, that are supposed for institutional merchants. This case can also be mirrored within the regulated crypto futures choices. Each the CME and Bakkt, the 2 regulated crypto futures buying and selling venues, have contract sizes of 5 BTC and 1 BTC, respectively. With costs at the moment exceeding $31,000, these contracts are evidently solely supposed for these prepared to make a major funding.
Nevertheless, blockchain affords important potential to rework the futures markets past cryptocurrencies via asset tokenization. Suppose a futures contract for the Nasdaq-100 or S&P 500 was made accessible as a token. In that case, it could possibly be traded in fractional increments, decreasing obstacles to entry and introducing new sources of liquidity into conventional markets.
Such a situation could profit these seeking to introduce a extra fine-grained diversification to their portfolio, which is at the moment solely doable by way of contracts for differences (CFD). Whereas they carry out an identical function within the monetary markets, CFDs are solely accessible by way of brokers, which reduces transparency for the dealer. It additionally fragments the accessible liquidity within the broader markets.
Regardless of their fast development, cryptocurrency futures markets are nonetheless very a lot of their infancy, significantly for the reason that institutional influx to crypto is barely getting began. Because the markets develop and develop, we’ll seemingly see new and extra subtle devices emerge, together with some blurring of the boundaries between conventional and digital finance. Moreover, it appears seemingly that the regulatory scenario will proceed to evolve as extra funds circulate in. One factor is for certain: cryptocurrency futures have an extended future forward.
This text doesn’t include funding recommendation or suggestions. Each funding and buying and selling transfer includes danger, and readers ought to conduct their very own analysis when making a call.
The views, ideas and opinions expressed listed below are the creator’s alone and don’t essentially replicate or symbolize the views and opinions of Cointelegraph.
Andy Flury is a serial entrepreneur and quantitative buying and selling skilled. Andy is a former Swiss Air Power pilot and led tasks on the Swiss intelligence company and numerous main banks. He additionally served as senior mission supervisor and software program architect at Siemens Switzerland AG. In 2010, Andy turned associate and head of algorithmic buying and selling at Linard Capital AG, a Switzerland-based quantitative hedge fund. Andy holds a grasp’s in industrial administration and manufacturing engineering from ETH Zurich and an Govt MBA from the College of St. Gallen.