It was expected that the rise in the price of bitcoin will result in increased interest and eventually new developments in the bitcoin world, and that is exactly what is happening. As more and more people get interested in bitcoin companies and exchanges are looking at new products they can create to get people to invest. Futures are one of the oldest forms of derivatives, and it is not a surprise that futures are the first product made to hedge on the value of bitcoin. The product is being introduced by the Chicago Board Options Exchange or CBOE in short.
How Futures Work
There’s a simple reason we are so interested in futures trading for bitcoin – it will invite bitcoin’s detractors to invest as well. Futures are basically contracts for a time in the future. Future contracts were started to help farmers diversify their risks and stabilize their income.
Here’s how they work. A farmer is growing wheat which he will sell after six months, once they are ready. Wheat is selling for $10 a bushel right now, and the farmer estimates that he will be able to get 1000 bushels from the crop. This means that the farmer, at current rates, will have wheat worth $10,000.
Now, the price of wheat varies. There is a possibility that the rate may go down, or it may go up. Traditionally it goes up, but the farmer wants to make sure that they get some money for their investment in the crops. They don’t want to risk the price falling so low that they don’t make any profit.
The farmer decides to sell a futures contract for 6 months later – saying that he will sell all the stock for $11,000. Now, there is a possibility that the wheat price may rise to $12 a bushel, resulting in the total cost being $12,000. However, now the farmer is guaranteed $10,000 at the end of six months, which removes his risk.
Now, the person who bought the futures contract doesn’t want the wheat – but that person may think that wheat may go up to $13 a bushel, resulting in him making a profit in the future.
How Futures Trading Will Work for Bitcoin
Futures trading will allow people who believe that Bitcoin’s prices are going lower to participate in the bitcoin surge. Here’s how it works. Suppose that you think bitcoin prices will have fallen to $5000 by the end of 2018, even though they are around $16000 at the end of 2017. Here’s what you do: You sell a futures contract, saying that you will sell 5 bitcoins one year later at the price of $10000 per bitcoin. Now, someone who disagrees with you will snatch up the opportunity – they’ll think it is a bargain to get bitcoin at just $10,000.
Now, if the price of bitcoin is higher than $10,000, suppose it is $20,000, you will still be obligated to procure 5 bitcoins and sell them each at $10,000. In such a situation you will lose $10,000 per bitcoin, of $50,000 on the whole transaction.
However, if what you think is right, if the price goes down to $5000, the buyer will still have to buy each bitcoin at the rate of $10,000 – earning you a profit of $5,000 per bitcoin. So even though the price goes down, you make a profit.
In a market as volatile as bitcoin futures contracts promise to be a very interesting and speculative product to own.