Bitcoin is increasingly being applied to some of the innovative investment tools in the traditional trading world, including in areas such as futures contracts – tools used to hedge against volatility in a number of financial assets. A futures contract is an agreement to buy or sell a particular commodity or financial instrument at a pre-determined price in the future. Futures contracts also detail the quality and quantity of the asset being traded. Beyond volatility hedging, futures are also employed as a tool of speculation.
Sometimes unstable, bitcoin price has had a history of appreciating and depreciating unexpectedly and rapidly, leaving investors and enthusiasts with either significant losses or gains with little warning. Futures trading has the opportunity to mitigate a portion of that risk as traders will be able to lock in a long-term valuation, protecting them from violent and sudden price swings. In addition to this, futures valuations could have an impact on the market price, bringing more stability to bitcoin in general.
Capital, LLC founder and managing member at CNBC.com, Brian Kelly wrote: “This is why the announcement of bitcoin futures-and-options … is so exciting. Derivatives can have a dampening effect on volatility, which will encourage more businesses to accept and hold bitcoin.”
Conversely, bitcoin futures could land investors in a lot of trouble, hurting the digital currency in the process. Futures contracts are often executed with ‘leverage’, in which the exchange loans a portion of the contract price to get traders started. In the event the value of a leveraged contract declines, the investor is responsible for covering the loss on the contract, as well as repaying the leverage granted by the exchange. To ensure they get their principle leverage back, exchanges can institute automatic ‘margin calls’, where positions are automatically liquidated at a certain price, kicking in before the asset valuation gets too low for the contract to cover its leverage. This practice has affected the bitcoin markets previously, leading to ‘flash crashes’ that creates panic in investors and sometimes resulting in a more long-term price depression due to panic selling.
However, as bitcoin trading gets more advanced, exchanges are developing tools to make trading more secure, allowing traders to enjoy benefits rather than suffering the fear of potential risks.
Crix.io, a digital currency futures exchange, employs what they describe as a ‘probabilistic risk model’, which assures that no margin calls or liquidations are necessary during 24-hour trading sessions, thus guaranteeing fair settlement. Founder Dmitry Koval says the platform is able to establish limits that prevent traders from suffering losses on shorter-term futures contracts.
For its three-hour and 24-hour contracts, model-predicted limits prevent traders from placing orders at a price point that has a low probability of coming true.
Koval remarked: “Real mathematics stands behind many aspects of trading today. This includes the volatility modelling and the Value at Risk method we use at our platform.”
While risk can never be entirely eliminated, advancements in bitcoin trading is making investments like futures contracts more viable and in doing so may help strengthen the cryptocurrency in the long term.