What are crypto futures contracts?
A crypto futures contract is an agreement between two parties to exchange the fiat-equivalent value of a cryptoasset, or the asset itself, on a future date.
Many think of futures as two people betting on the future price of an asset such as Bitcoin (BTC) or Ether (ETH). One person believes the price of the asset will be higher at an agreed date in the future. This view is known as going long.The other person thinks it will be lower by the agreed date. This view is known as going short.
In crypto futures trading, a trader profits if their price prediction about a contract's underlying digital asset comes true. If a trader believes the price will increase, they can go long on a futures contract, with the aim of selling it later at a higher price. If they believe the price will decline, they can go short. The shorting process involves selling a contract they don't own with the intent of buying it back later at a lower price (and trying to profit from the difference).
Futures exchanges match the buyer with the seller of each futures contract, meaning platforms like Kraken Pro are not a counterparty to any futures trade. Additionally, the "loser" of the bet must pay the difference between the settlement price and the underlying asset's current spot market price to the "winner."
Crypto futures contracts are one of the most popular types of crypto derivatives available to crypto traders. Derivatives have grown into a significant part of the global cryptocurrency economy. Crypto derivatives now account for more than half of all crypto trading volume, which equates to billions of dollars each day.
You can learn more about trading futures in Kraken Pro here.
Summary of crypto futures contracts
- Futures markets trade in a similar manner to the spot markets they represent. That's why they are often called derivatives, as they derive their value from an underlying asset. However, there are some key differences.
- With futures, you don't need to buy or hold the crypto to take advantage of price volatility.
- Taking positions on futures markets typically incurs much lower trading fees than on spot markets.
- Overall, futures markets are more popular with institutional investors worldwide. However, they are entirely speculation-based (focused on the value of an asset), rather than utilizing the asset by purchasing it directly.
Crypto futures trading fundamentals
Kraken Futures matches the buyer with the seller of each futures contract, meaning the trading platform itself is not a counterparty to any trade.
When a trader buys a futures contract, he or she profits when the contract’s price rises (which happens when the underlying cryptoasset’s price rises).
When a trader sells a futures contract, he or she profits when the contract's price falls (which happens when the underlying cryptoasset’s price falls).
Futures trading is a zero sum game, meaning one party must incur losses for the other to realize gains. Because a futures contract is an agreement directly between traders, both buyer and seller need to agree upon the details of the contract before it is brokered.
A cryptocurrency futures contract consists of three main components:
1. Expiration date
The expiration date is the date on which a contract will close and value will be transacted. The expiration date is agreed upon when futures traders enter into the contract at the previously agreed upon price. Some platforms, including Kraken Pro, also offer perpetual contracts. These are a type of futures contract that have no expiration date. Instead, they use a funding rate that helps to keep the futures price inline with the spot market value of the asset.
2. Contract lot size
Contract lot size defines the amount of the underlying asset that a futures contract represents. A single contract can be priced in terms of its underlying asset (1 contract = 1 BTC) or a currency (1 contract = $1 worth of BTC).
Futures traders can also use fractional trading. For example, even though a contract's unit size is 1 BTC, a trader can buy or sell a lot size as small as 0.0001 BTC.
Traders often can trade futures contracts with leverage. Leverage simply means a trader can take control of a high-value contract with a comparatively small deposit.
For example, a person buying a Bitcoin Futures contract worth 5 BTC/notional value $150,000 might only need to pay a 10% deposit ($15,000). This increases their trade size by a factor of 10x. Depending on the asset and amount traded, different leverage (or margin) rates apply.
The method of settlement can also vary. Most platforms allow traders to settle their contracts in cash. This means the person who "loses" the bet pays the "winner" in a fiat currency like the US dollar. This process is known as cash settlement. However, in some circumstances, platforms may allow traders to settle in the underlying asset. The financial markets call this physical delivery. In this instance, the seller must hold digital currency and sell it directly to the buyer at the agreed settlement price.
The difference in price between the contract settlement price and the current spot price determines how much profit the winner makes.
Futures trading account requirements
Crypto futures trading exchanges require collateral margin (crypto, cash, or stablecoin) to open a futures position. If the market price of an asset drops far enough that the assets held as collateral are not enough to cover a trader's open position, the crypto exchange may automatically liquidate the trader's position. Liquidation is a common form of risk management on many futures trading platforms.
Exchanges may issue a notice to traders known as a margin call before liquidation occurs. Margin calls inform traders of the need to top up their maintenance margin if their funds run low (to avoid liquidation).
Because a futures contract is an agreement directly between traders, both buyer and seller need to agree upon the details of the contract beforehand.
What are the advantages of crypto futures trading?
Despite their complexity, futures offer a variety of benefits over the spot market that some traders may need. They can choose to use these depending on their expertise in the markets, trading strategies, and risk appetite.
- Speculation: Futures allow traders to speculate on the future prices of specific cryptoassets and take advantage of price swings in either direction. Opening a short position on a futures contract is one of the easiest ways to profit as its underlying cryptoasset's price falls.
- No asset ownership: Futures are a financial contract that provides exposure to cryptoasset prices without having to take ownership of the cryptoasset itself. Traders can buy a contract and recognize their profit without ever having owned, transacted, or held the underlying cryptocurrency. This convenience has been an attractive feature for professional investors who wish to engage with crypto assets, but may be unfamiliar with navigating crypto exchanges or managing crypto wallets.
- Fees: Futures trading fees are generally much lower than spot trading fees. Kraken Futures offers one of the most competitive fee structures in the crypto futures market, with fees as low as 0.01%.
- Leverage: Futures traders can take advantage of leverage. Platforms build leverage into futures contracts. This feature allows for increased capital-efficiency when trading. However, it’s important to note that exchanges can liquidate leveraged positions.
- Hedging: If a trader owns a cryptoasset, they can enter into a short futures position which reduces their exposure to (or "hedges" against) falling prices. This strategy can be effective to protect spot market positions against downward price movements without having to sell them.
- Arbitrage opportunities: Arbitrage trading futures can allow traders to take advantage of pricing discrepancies across multiple futures exchanges. In some instances, a trader can profit by shorting and longing the same underlying asset on two different futures exchanges. This situation is usually only possible if two futures contracts on two different exchanges track prices similarly, offer the same leverage, share a similar settlement date, and settle in the same currency. The arbitrage trader holds both contracts open until the two contract prices converge and makes a profit.
How are futures markets different from spot markets?
In a spot market, a single asset is bought and sold at current market prices. Traders exchange one asset, like USDT, for another asset, like BTC. This settlement method is known as immediate delivery because assets transfer at the point of sale.
Futures traders, on the other hand, agree to settle their contractual agreements at a predetermined date in the future.
Additionally, futures give crypto exchange clients access to leverage. This leverage means futures traders can open larger positions using a comparatively small initial deposit (known as initial margin).
Leverage causes significantly increased profits from winning trades, but amplified losses from losing futures trades. It is for this reason that many platforms advise beginner traders to avoid trading futures until they're more experienced.
The main difference between spot and futures is exposure. With spot trading, crypto traders become directly exposed to the crypto market by holding the underlying asset(s) in their crypto wallet. Trading in crypto futures, however, allows exchange clients to gain indirect exposure to the price fluctuations of a cryptocurrency without needing to hold or self-custody that cryptocurrency itself.
How are crypto futures different from traditional futures contracts?
The underlying assets of standard futures contracts are often commodities such as crude oil or copper. Banks initially created these contracts to allow farmers to lock in prices for their produce at a future date. With crypto futures, however, contracts track digital asset prices such as Solana (SOL) or Chainlink (LINK).
Traditional commodity futures offer lower leverage when compared to crypto futures.
CME Group, for example, offers 10x leverage on their Micro WTI crude oil futures contract. Historically, some cryptocurrency trading platforms have offered as high as 100x leverage. This leverage means a crypto trader could have opened a futures contract worth $100,000 with an initial deposit of $1,000. It also meant that a trader could have doubled their $1,000 with a 1% price move in their direction – or lost the entire $1,000 with a 1% move against it.
It's worth noting that many digital currency platforms no longer offer these levels of leverage.