Intro to Bitcoin Futures Pricing
Over the last several years, Bitcoin (BTC) futures trading has become commonplace in the crypto industry. Many exchanges now offer multiple types of Bitcoin futures trading products, allowing traders a different way to trade the price action of crypto’s top asset.
Futures Trading Basics
In a nutshell, trading futures means you are speculating on the future price of an underlying spot asset without buying or selling the underlying asset itself. A spot asset is simply an underlying asset, such as gold.
In the traditional financial world, participants might choose to trade futures on something such as gold. Essentially, trading gold futures means speculating on the price of gold, buying or selling contracts that each represent a certain amount of gold, while not directly buying actual gold in the process.
Futures contracts often come with expirations, such as monthly and quarterly expirations.
Futures trading for each defined period (monthly, quarterly, etc.) stops at the expiration date, and positions held through expiration are paid out, either in the asset itself or in cash, depending on the purchase price and size of the position relative to the price of the underlying asset at expiration. This payout is called settlement.
At the beginning of each futures period, the price of these futures products often varies slightly from the price of their underlying assets, growing closer to the prices of the underlying assets as expiration draws nearer.
This type of market state is known as “contango” whenever the price of a futures product is higher than the price of its underlying asset at any given time, i.e. at a premium. In contrast, “backwardation” is when a futures product is trading lower than the price of its underlying asset, i.e. at a discount.
Bitcoin Futures Pricing
Bitcoin futures are traded based on the price action of spot Bitcoin (the underlying asset), and its “fair market value” price. Fair market value price is essentially market equilibrium. It is the price at which a Bitcoin seller and buyer come to a price agreement on an exchange, transacting the asset.
The fair market price of spot Bitcoin should be relatively the same on most higher volume exchanges, representing the price at which you can enter the market and buy Bitcoin at any given time. Arbitrage trading - buying BTC where it is sold more cheaply and selling it on exchanges where asset trades higher - often ensures that Bitcoin’s price trades at nearly the same level on most high volume exchanges.
Additionally, BTSE’s Liquid integration has the potential to expedite the transfer of Bitcoin. BTSE’s Liquid Network integration involves Liquid Bitcoin (L-BTC), a token pegged 1:1 with Bitcoin with proof of reserves locked on the Bitcoin blockchain. L-BTC has one minute block times and is fully tradeable within two confirmations (two minutes) of the transaction. L-BTC also has confidential transactions which hide the amount L-BTC you are transferring.
This fair market value concept is also true regarding the value of Bitcoin futures trading, depending on the type of futures product being traded and its expiration. Bitcoin futures should all trade near the same price as long as the futures product, expiration, and exchange type are the same. That said, differences in contract specifications can lead to differences in futures prices.
Bitcoin futures are similar to traditional market futures, with many exchanges offering monthly and quarterly expiration products. Such products can also be settled in cash or spot Bitcoin, depending on the exchange offering the product.
As noted, futures pricing can vary from underlying asset pricing. For example, on the first day of December, Bitcoin monthly futures might trade at $10,000 per the contract equivalent of 1 BTC, while each spot Bitcoin trades at $9,900. This would be a contango situation. By the end of December, near the time of expiration, you might expect the two prices to converge. This means the price of futures product should trade very closely to the spot price, depending on the state of the market.
The inverse of this situation can also occur if a monthly contract period begins with Bitcoin’s spot price trading higher than its futures price.
Many exchanges in the crypto space also now offer Bitcoin perpetual swap futures, which have no expiration. Instead, these products host funding (long positions pay short positions a small fee, or vice versa) which occurs at set points throughout the day, keeping perpetual futures prices close to Bitcoin’s spot price. As an example, when perpetual futures trade at a premium, the funding rate would imply the long position holders paying the short position holders a small funding amount. This creates downward pressure on the futures price and thus reduces the futures premium. As a result of the funding mechanism, Bitcoin perpetual futures usually trade at almost the same price as Bitcoin’s spot price.