Cryptocurrency Futures Trading: How to Get Started

One way that investors can take advantage of the big swings in the crypto market is by trading crypto futures. While futures trading promises lucrative returns, it also features risks that we will discuss in this article. 

What is crypto futures trading?

As the name suggests, a futures contract is a financial instrument designed as a contractual agreement where one party promises to either buy or sell an asset at a future date. Crypto futures are similar to traditional futures contracts in that they both involve a contract to buy or sell an asset at some point in the future. The difference is that futures contracts are exchange-traded, meaning you’re buying and selling them with other investors on regulated exchanges such as CME Group (the company behind the famous Chicago Mercantile Exchange) or NASDAQ OMX.

Crypto or Bitcoin futures on the other hand are traded on unregulated exchanges, most of which have laxer financial regulations. Futures contracts are regulated a lot more heavily than crypto futures and offer less potential for astronomical returns given they operate in a relatively stable market.

How does it work

Much like traditional futures contracts, crypto futures are considered derivative financial contracts that derive their value from the underlying asset. However, unlike Exchange Traded Funds and other forms of derivative financial instruments, crypto futures contracts do not track the price of the asset. Instead, they place an obligation for buying or selling the asset regardless of its price in the future. For instance, if you enter a futures contract position for buying bitcoin at a current price of $10,000, you agree to buy Bitcoin at that price no matter its current price in the future. Therefore, if Bitcoin rises, you lose and if it drops past its previous mark, you gain. 

In addition, a futures contract typically involves leverage thus allowing the trader to amplify their gains by entering much higher than their capital can allow. 

The crypto futures market works in many ways like the futures contracts in the traditional finance sector but with some key differences. The two are similar in that they both derive their value from the underlying asset. The price of the futures contract is dependent on the spot price which is the current price in the market. In other words, if Bitcoin or a particular stock is trading at $1300 and there are 100 contracts on that price then each contract will be worth $130 (or 0.13 BTC). The difference between crypto futures and traditional ones is that with crypto futures, you’re buying or selling a cryptocurrency instead of an index such as stocks.

Benefits of crypto futures trading

Trading crypto futures can be a great way to trade in cryptocurrencies without taking on the risks of owning cryptocurrencies outright. Futures contracts are regulated and offer less opportunity for manipulation or fraud. This can give institutional investors more confidence as they often place large positions with their trades. 

Another advantage is that you get better leverage than trading in other markets, which means more potential reward but also higher risk if Bitcoin drops significantly.

Trading crypto futures is also a relatively new concept making the marking more attractive right now. So, you can take advantage of this by trading on less well-known exchanges with more lax financial regulations (meaning there’s more risk but also potentially greater rewards if Bitcoin or other cryptocurrencies continue to grow in popularity).

Risks of crypto futures

The risks of trading crypto futures include the fact that cryptocurrencies are highly volatile, unpredictable, and often difficult to value. Furthermore, futures contracts also come with their own set of risk factors that make them different from outrightly buying cryptocurrencies.

Leverage

For starters, crypto futures use leverage; as mentioned earlier, futures contracts typically come with higher leverage than buying Bitcoin or other cryptocurrencies. Therefore, as a crypto futures buyer, you can trade larger positions than your capital can allow using an initial margin where you only use a percentage of your capital to cover the total price of your purchase as a form of collateral. Currently, the initial margin requirement set by the Federal Reserve Board is set at 50%. This means that if the price of a contract rises fivefold but then falls 50%, you’ll only lose about half your investment (so long as you cut out your losses when they reach 100%). 

Expiry date

While the original idea for a futures contract is based on trading commodities, instruments such as crypto futures allow retail traders and portfolio managers who are not interested in the delivery of the underlying asset to benefit purely from the profit potential of futures contracts. However, the condition for making profits is base on the expiration date of the futures contracts. The crypto futures contract buyer must close their position within the deadline or risk losing through margin maintenance. Since crypto futures contracts can be leverages, a seller can require the buyer to hold a minimum equity in the account. The volatility of crypto assets might require an increasing amount of maintenance margin.

Binding contract

Another risk of trading crypto futures is that you may be unable to get out of a contract once it’s been bought. This is because the contract is binding and states that you have to sell it back at a certain price (which may or may not be fair), and if Bitcoin has fallen in value then there’s no way for you to make up the difference, so your losses are capped at 100%. 

Untested

A final risk of trading crypto futures contracts is that their market is still relatively new. This means you may have less information to go off of and even if a contract has been in circulation on an exchange before, there may be no open contracts available when trading begins.

What you need to get started

There are a couple of things you will need to get started trading crypto futures. Since crypto futures contracts are designed to speculate on the price movement of cryptocurrencies such as Bitcoin, you will not need any kind of cryptocurrency wallet. 

Regulated exchange

First, find an exchange that’s registered with the Commodity Futures Trading Commission (CFTC) or a license in your local area. Once you find a regulated exchange, you will realize that some exchanges require you to have a minimum balance of at least $25,000 before trading futures contracts. This requirement varies from one platform to the other.

Find a broker

The second step is to find a broker that offers trading in cryptocurrency futures markets. In most cases, the broker will also be the exchange platform. Here are a couple of options to consider.

Interactive Brokers: This broker is one of the industry’s most highly rated and comes with an initial margin requirement of $16,562 with a similar amount for initial margin on overnight open positions. With a set commission of $15.01 per contract, you will get a desktop trading platform with this broker as well as a wide range of available account types. 

Forex.com: Trades with Forex.com go through a subsidiary platform with full oversight from the CFTC. This broker comes with a minimum balance requirement of $500; however, it is best to open an account with a deposit of about $3,000 to cover any margin requirements. With Forex.com, there is a $15 fee for inactive accounts, and a commission of $1.29 per futures contract is required with every trade. 

Tradovate: This broker is one of the most affordable in the market and features a commission-free trading experience that saves you money. Tradovate is a first of its kind online futures broker with a membership-based pricing model. You can access their platform through mobile as well as a desktop application. Tradovate is also a member of a CFTC delegated registration organization called the NFA (an industry-wide self-regulatory organization in the US).

What’s more, you can access more brokers and review their terms to find one that is favorable for our trading needs. Once again, make sure that they’re licensed and registered with the CFTC.

Tips for success in crypto futures trading

Understand the risks

Don’t make trades without fully understanding what you’re getting into. Understand the risks of your investment before trading, as well as the potential rewards, are important. This includes everything from knowing how leverage works to figuring out which exchanges have licensed contracts available that meet your needs. 

Manage the risk

Only trade with money you can afford to lose. Don’t trade with more leverage than you’re comfortable using. Only use a small percentage of your portfolio for futures trading (maybe only one or two contracts). Keep in mind that every contract is different, so make sure to read the terms and conditions before buying. This includes understanding the expiration dates of each contract and the commissions and fees that come with each broker.

Prepare a trading plan

Set up a plan that allows you to only trade cryptocurrency futures based on a careful analysis of the risks and rewards. Consider your objectives and conduct technical as well as fundamental analysis before entering any position. Also, expect large price swings and keep good records of all your trades as everything can change at any time.

FAQs

Are crypto futures better than stock?

Crypto futures are very similar to trading stocks on the stock market. Crypto futures may be more advantageous for you because they’re not taxed like normal currencies but instead are subject to capital gains tax and long-term holding taxes. This is due to crypto being classified as a commodity instead of a currency which makes it easier for us to trade on the futures market.

Crypto is considered a commodity because the SEC doesn’t consider it as an investment so therefore traders have to pay taxes. However, most other countries don’t apply any tax on crypto trading which means that your gains are not taxed like stock futures and can be traded without paying any taxes. This makes cryptocurrency trading extremely profitable for you in the long term.

What is the difference between spot and futures trading?

The most notable difference between these two types of trades is that Spot trading offers a way to deal with discrepancies in supply and demand, while futures trading offers a way to hedge against future price fluctuations.

Spot Trading is the act of buying and selling commodities or securities for cash on an exchange at current market prices. This type of trade is usually completed within one business day.

Futures Trading, on the other hand, allows you to buy goods at an agreed-upon price today and pay for them in the future. This may be useful if you are uncertain about what will happen to prices in the future or want more to speculate on the price of an underlying asset. 

Are futures and forwards the same thing?

Futures and forwards are both derivatives contracts that function similarly but with distinct differences. For a start, futures contracts are exchange-traded and feature a standardized contract specification. Forwards on the other hand trade over the counter and the terms of the contract are customized by the two parties engaged in the trade. 

Conclusion: Closing thoughts

In closing, trading crypto futures contracts is a great option for those looking to take on more risk than they would with other investments. With a crypto futures contract, you can make a lot of money if Bitcoin prices go up based on your prediction, but you can also lose everything in an instant should the price fall beyond your initial entry price. Make sure you fully understand how leveraging works before taking the plunge. Crypto futures contracts have a specific contract obligation, which means you may have to settle the difference in cash. In most cases, the trader will opt to pay or receive cash settlements depending on whether their forecast was right or wrong. While it is rare to see cases that require the physical delivery of Bitcoins or other cryptocurrencies, it is always a good idea to have a secure crypto wallet that lets you invest directly in the crypto market.