How Bitcoin Futures Affect Price
Tags: Bitcoin Price, Bitcoin Futures, Bitcoin, Bitcoin News, Cryptocurrency

About one year ago, Bitcoin futures were launched in the market. Since then, it has gained massive popularity. It helps traders who cannot hold spot positions in bitcoins due to its complicated regulations. They can trade bitcoin futures. Future contracts also offer traders with hedging possibilities and risk mitigations. In this article, we will discuss in detail how bitcoin futures affect the price.

Bitcoin Futures and Bitcoin Spot Price

There are various exchanges to trade bitcoins. These exchanges release bitcoin contracts that last for three months in the future. For example, a bitcoin future launched in March will expire in May.

This type of contract is launched every month. An initial price for these contracts is set by market makers and the trading begins. As trading begins, the price of the contract depends on the demand and supply mechanism in the market. If the demand is more and supply is less, the price increases. Consequently, if the supply is more and demands less, the price decreases.

Any move in bitcoin spot prices has a direct effect on bitcoin futures. This dependency results in a synchronous movement in both the prices.

Fortunately, we have the formula to calculate the price of bitcoin futures from bitcoin spot prices.

Futures Price = Spot Price * (1 + rf — d)

Where rf stands for risk-free rate on an annual basis

And d stands for dividend

In the case of bitcoin this formula can be customized as follows:

1. The change in risk-free rate from an annual to a daily basis

2. There is no dividend in case of bitcoin so ‘d’ can be eliminated.

So the new formula is:

Bitcoin Futures Price = Bitcoin Spot Price [ 1 + rf (x / 365)]

Where x represent the no. of days left before expiry.

This formula is based on the concept of the cost of carrying. Anyone interested to invest in bitcoin futures contracts can also invest in secure bonds to earn a minimum risk-free rate of return. Hence, this formula also includes computation of returns which are at par with the risk-free rate over time till the contract expires.

Let’s verify this against a real-world example. Let us assume a situation where the risk-free rate value is 2.25%, $8,171 is the bitcoin spot price. Substituting these values in the formula above, the futures value comes at $8,175.3. This theoretically calculated is almost equal to the real price of $8,180 where the contract was closed as of April 18.

This small difference of $5 can be attributed to brokerage charges and market volatility. These factors can shift your payout by a few dollars.

Real-World Price Determination

The theoretical concept is fine. But when we come to real-world bitcoin futures price tend to have some wild swings in either direction. There may be times when futures contracts will not follow spot prices; they will not be in sync. Why does this occur? Let us try to understand.

This difference is because of the fact that the formula does not account for volatility in the market.

The market participants cannot ignore volatility.

If there are only two days left in the expiry of bitcoin futures, the formula tells us the price of bitcoin future must be very close to bitcoin spot price. However, due to high volatility in the market, its price can shoot up very high or very down within hours.

Moreover, there may be other market events that can fuel volatility. Like a particular market like India imposing a ban on cryptocurrency. This will be very bad news for the market and this will be reflected in the spot price. Also, bitcoins are traded 24/7 which means the market is always volatile. Its price may change within hours or even within minutes! However, the future market remains open only for a specified duration of hours. It may be the case that future price closed very close to the spot price on Monday. But overnight some local developments can change the price of bitcoin. Consequently, bitcoin futures and bitcoin spot price opens with a wide gap on Tuesday morning.

It’s unfortunate that this theoretical formula does not account for such instances. These small local or geographical developments have the power to drastically change the price of bitcoin. This uncertainty makes bitcoin futures a guessing game. Closer your guess to the actual spot price, better are your chances of profit.

How Bitcoin Futures Affect Price?

An interesting thing occurs when the people holding bitcoin futures decide to hold their gains. These gains become cumulative. The result is a steady rise in the market cap of BTC/USD.

Long Term Effect: If we compare bitcoin with gold, silver or platinum, we find that bitcoin futures will have little or no effect on the price. When gold was added to futures, it did not have any impact compared to international, political, and economic events.

Short Term Effect: Gold, silver and platinum data were available daily, these showed quite a bit of volatility.

In short, for the long term investor, futures don’t affect the price of bitcoin much. For a trader, it can be an event of great profit.

Why is this interesting? Surely futures can have a short term effect on bitcoin spot prices, but the long term price will be more dependent on events in the Bitcoin community like:

· Politics in the bitcoin/crypto community

· Institutional investment

· Government rules and regulations

· Competing cryptocurrencies

· Major bitcoin conferences around the world.

The Bottom Line

In spite of all the inconsistency and speculative mechanism involved with bitcoin futures, it remains a high stakes game. People are drawn towards it maybe because of the buzz or they have confidence in their guess. Combining this with 25/7 trading of spot prices, bitcoin futures become more complicated. However, this volatility and uncertainty also allow for huge profits.

NOTE: Investing in cryptocurrency and Initial Coin Offerings (ICOs) is a highly risky game. The writer does not recommend any such investment. If you really want to invest, consult your financial advisor for more information.