Summary

Bitcoin futures contracts are derivatives similar to traditional futures contracts. Both parties agree to buy or sell a fixed number of Bitcoins at a specific price on a certain day. Through futures contracts, traders can both speculate and hedge losses. Hedging is a common method used by miners and can effectively cover operating costs.

Contracts are a great way to diversify your investment portfolio, operate leveraged trades, and stabilize future income. To explore advanced strategies on contracts, take a look at arbitrage trading. If executed correctly, forward arbitrage and cross-exchange arbitrage can create some low-risk trading opportunities.

Introduction

Bitcoin futures contracts are alternative investment opportunities for ordinary currency holders. For more complex products, an in-depth understanding of their mechanisms is required to carry out safe and reliable transactions. Although difficult to use, contracts provide an effective way to lock in price through hedging and profit from market declines through short selling.

What is a Bitcoin contract?

Bitcoin contracts are financial derivatives similar to traditional futures contracts. In short, both parties agree to buy or sell a fixed number of Bitcoins at a specific price (forward price) on a certain day. If you go long (agree to buy) a Bitcoin futures contract and the mark price at expiration is higher than the forward price, you can make a profit. The mark price is an estimate of fair value based on the asset's spot price and other variables. We will discuss this issue in detail later.

If the mark price at expiration is lower than the forward price, the contract loses money and the short position makes a profit. A short position occurs when a trader sells a loan or owned asset in anticipation of a fall in price. When the price drops, traders repurchase the asset and earn a profit. Contracts can be settled via physical exchange of the underlying asset or, more commonly, cash.

Why use Bitcoin contracts?

One of the main uses of Bitcoin contracts is for buyers and sellers to lock in future prices. This process is called "hedging". Contracts have historically been a hedging tool in commodity markets. Producers in the commodity market need stable earnings to cover various costs.

Traders can also achieve speculative purposes through contracts. Use long and short positions to predict market trends and take the plunge. In a bear market, short positions can still be profitable. There are also many possibilities for arbitrage trading and other complex trading strategies.

Advantages of trading Bitcoin contracts

Hedging

Hedging appears to be physical The role is greater in commodity markets, but the same applies to cryptocurrency markets. Bitcoin miners and farmers alike need to bear operating costs and want a fair price for their products. Whether it's a contract market or a spot market, hedging can work. Next, let's take a look at how it works.

Futures Contracts

Bitcoin miners can short futures contracts to protect their Bitcoin assets. When a futures contract expires, miners must settle with the other party to the contract.

If the Bitcoin price (mark price) in the contract market is higher than the forward price of the contract, the miner should pay the other party the difference. Conversely, if the mark price is lower than the forward price of the contract, the other party holding the long position should pay the miner the difference.

Spot Market

On the expiration date of the futures contract, miners sell Bitcoin in the spot market. Bitcoins are sold at market price, which approximates the marked price in the contract market.

However, spot market transactions will effectively offset any gains or losses in the contract market. The sum of the two is the hedging price that miners hope to obtain. Below we combine the two steps and illustrate them through data.

Combining futures contracts and spot trading

Miners shorted 1 Bitcoin for a 3-month contract at a price of $35,000. If the mark price at expiration is $40,000, the miner loses $5,000 at settlement and the difference is paid to the long side of the contract. At the same time, miners sell 1 Bitcoin in the spot market, and the spot price is also $40,000. The miner received $40,000, covering the $5,000 loss, and the remaining $35,000 was the hedging price.

Leverage and Margin

For investors, margin trading is extremely attractive. It allows traders to borrow funds and take positions beyond their financial capacity. Small price changes are magnified, and larger positions result in higher returns. The risk of this mechanism is that if the market trend goes against the direction of the position, the principal is likely to be forced to be liquidated quickly.

Leverage on trading platforms is usually displayed in multiples or percentages. For example, 10 times means the principal multiplied by 10. Therefore, $5,000 using 10x leverage is equivalent to trading with $50,000. When using leveraged trading, the principal used to cover losses is called "margin". Specific examples are as follows:

If you purchase 2 Bitcoin quarterly futures contracts at a price of US$30,000 each. The trading platform allows trading with 20x leverage, so only a $3,000 principal is required. This US$3,000 is used as a margin, which will be deducted by the trading platform after losses occur. If the loss exceeds $3,000, your position will be liquidated. Divide the leverage ratio by 100 to calculate the margin ratio. 10% margin corresponds to 10x leverage, 5% corresponds to 20x leverage, and 1% corresponds to 100x leverage. This ratio represents how much the contract price can fall. Once it falls to the lower limit, the contract will be forced to liquidate.

Portfolio Diversification

Use Bitcoin contracts to build a diversified portfolio and adopt new trading strategies. We recommend incorporating different tokens and products to build a balanced investment portfolio. The attractiveness of the contract is reflected in the provision of various trading strategies, breaking the limitations of long-term holding. In addition, low-risk carry trading strategies with lower profit margins can also reduce the overall risk of the portfolio. We will discuss these strategies further later.

Binance’s Bitcoin Contract

Although they are both futures contracts, the details are different. Contract products on different trading platforms differ in terms of mechanisms, expiration dates, pricing and fees. Currently, the main differences between the various Binance futures products are expiration dates and funding fees.

Expiration Date

So far, we have only introduced contracts with a clear expiry date. Binance’s futures trading platform offers quarterly contracts, while other exchanges have also introduced monthly and semi-annual (expiration date) contracts. The expiry date is clear by looking at the name of the contract.

Binance’s Bitcoin quarterly contracts follow the following calendar periods: March, June, September, and December. The BTC/USD 0925 quarterly contract will expire at 16:00:00 (Hong Kong time) on September 25, 2021.

Another popular option is trading perpetual contracts with no expiry date. Compared to quarterly contracts, perpetual contracts handle profits and losses differently, and there are also funding fees.

Funding Fees

When buying Bitcoin quarterly contracts on Binance, sufficient margin must be deposited to cover potential losses. However, this potential loss only needs to be repaid when the position is liquidated or the contract expires. In the case of perpetual futures contracts, there is a funding fee that needs to be paid/received every eight hours.

Funding fees are peer-to-peer payments between traders. These fees prevent the forward price of a Bitcoin perpetual futures contract from deviating from the mark price. The mark price is similar to the spot price of Bitcoin, but is designed to avoid unfair liquidations during severe market fluctuations.

For example, a one-time transaction in the spot market is likely to temporarily increase the price by thousands of dollars. Such fluctuations may result in forced liquidation of contract positions, making it difficult to reflect the true market price. The funding rate is highlighted in red in the image below, with the expiry date next to it.

If the funding rate is positive, it means that the price of the perpetual contract is higher than the mark price. When the market for a contract is bullish and the funding rate is positive, long traders should pay short traders a funding fee. If the funding rate is negative, the price of the perpetual contract is below the mark price. At this point, the shorts pay the longs.

The concept of funding rates is complicated. Please visit Binance Futures Funding Rate Introduction for details.

Coin-margined contracts and U-margined contracts

Binance offers two contract trading options: coin-margined contracts with cryptocurrency as margin, and U-margined contracts with BUSD/USDT as margin. contract. Both types of contracts can be perpetual contracts, but they are slightly different.

Coin-based contracts must use the underlying assets of the contract as collateral for the contract margin account. U-based contracts allow the use of cross-collateralization. This feature allows users to borrow USDT and BUSD at 0 interest rates using crypto assets from spot wallets as collateral.

Coin-based contracts are commonly used by miners who wish to hedge their Bitcoin positions. Such contracts are settled via cryptocurrency, eliminating the need to convert Bitcoin into stablecoins and introducing redundant steps in the hedging process.

How to trade Bitcoin futures contracts?

To trade Bitcoin futures on Binance, just create an account and deposit a small amount of money. Here is a step-by-step guide to trading Bitcoin futures contracts:

1. Create a Binance account and enable 2FA (two-factor authentication). If you already have an account, be sure to enable two-factor authentication in order to deposit funds into your contract account.

2. Buy BUSD, Tether (USDT) or other supported cryptocurrencies for contract trading. The most convenient way is to purchase with a debit or credit card.

3. Go to the Bitcoin Contract Overview and select the type of contract you wish to purchase. Choose a coin-margined contract or a U-margined contract, and whether it is a perpetual contract or a contract with a set expiry date.

4. Choose a reasonable leverage ratio. You can perform this operation on the right side of the [Cross Position] button in the trading user interface. Remember: when you increase your leverage, even small price fluctuations increase the risk of being forced to liquidate your position.

5. Please select the quantity and type of the order, and then click [Buy/Long] or [Sell/Short] ], establish a Bitcoin contract position.

For detailed instructions, please read the "Ultimate Guide to Binance Futures Trading".

Bitcoin contract arbitrage trading strategy

In the above, we introduced the long and The basics of short trading, but there are other trading options available. Futures contracts are similar to the foreign exchange market, and arbitrage trading strategies have a long history. Traders apply these techniques in traditional markets, and they apply equally well to the cryptocurrency market.

Cross-trading platform arbitrage

As long as the prices of futures contracts launched by different cryptocurrency trading platforms are different, there will be opportunities for arbitrage trading. Buy a contract on a cheaper exchange, then sell another contract on a higher-priced exchange, earning the difference.

For example, let’s say Binance’s BTC/USD 0925 quarterly contract is $20 cheaper than other exchanges. Arbitrage can be made by buying a contract on Binance and then selling another contract on an exchange with a higher price. Of course, with the influence of automated trading bots, prices can change rapidly. You have to get the best of your timing as the difference can disappear at any time. When calculating your benefits, don’t forget to include the fees you have to pay.

Forward arbitrage

In contract trading, forward arbitrage is a market-neutral position and is not a new thing. A market neutral position is one where you buy and sell an asset in equal amounts at the same time. In this case, traders can ignore price factors and simultaneously go long and short the same futures contract by equal amounts. Cryptocurrency contracts can create more substantial profit margins through forward arbitrage than traditional commodity contracts.

Cryptocurrency contracts trade less efficiently than traditional markets, increasing arbitrage opportunities. To successfully implement this strategy, you should find a point where the spot price of Bitcoin is lower than the contract price.

After determining the point, establish a short position with a futures contract, and at the same time buy the same amount of Bitcoin in the spot market to make up for the short position. Once the contract expires, the purchased Bitcoin can be used to settle the short position and earn the previously found price difference as arbitrage.

Why did this opportunity arise in the first place? The reason is that although there is no money to buy Bitcoin at the moment, people believe that the price will rise and are naturally willing to pay a higher contract price. For example, if you believe that Bitcoin will be worth $50,000 in three months, it is currently worth $35,000.

You are temporarily short of funds, but the funds will be available in three months. At this time, a long position with a small premium can be established at $37,000, scheduled for delivery three months later. The essence of forward arbitrage is to hold other people's Bitcoins for a fee.

Summary

Bitcoin contract trading has long been experienced in the traditional financial field. Derived from the tested products, it finally took root in the cryptocurrency field. The cryptocurrency contract market is currently hugely popular, with high volume and liquid trading platforms readily available. Nonetheless, trading in the Bitcoin futures market involves a high degree of financial risk. Before starting a transaction, you must fully understand the working mechanism of contract trading.