Futures trading and how it works

September 20, 2023
Last Update December 07, 2023

Crypto futures are a contract between two traders that bet on the future price of a coin. Futures trading allows traders to trade with assets or rather trade by betting on the assets’ prices without buying the assets.

Let’s have a look at how it works.

A futures contract has the following main components:

Expiration date: a date when the contract must be settled. On this day, one party has to buy, and the other party has to sell the asset at a pre-agreed price. Traders can sell their contracts to other traders also before the expiration date.

Units per contract: it defines how much a contract is worth in the asset units.

Leverage: capital borrowed by a trader from an exchange. It allows trading with more money that is available for a specific trader.

Futures contracts can be settled in two ways:

Physically delivered: when traders buy and sell the contract asset, for example, Bitcoin, Ethereum, etc.

Cash-settled: when traders transfer cash (between a buyer and a seller).

Example of how a futures contract works

Take, for example, a Bitcoin futures contract. Normally, the minimum of such a futures contract is 5 BTC. If a trader buys two BTC futures contracts, and one Bitcoin cost $15,000 at the time of the purchase, the total value of both futures contracts is $150,000. If a margin requirement for BTC futures trading on that trading platform is 50%, the trader shall deposit 50% of the futures contracts’ entire value, which is $75,000. The rest can be financed by using leverage (borrowed capital).

If, after the contract expiration, BTC grew to, say, $25,000, the trader receives $250,000 in the contract settlement. He repays the borrowed funds, and the rest is the profit he gains. But if BTC drops below $15,000, the trader bears the losses but also has to repay the borrowed funds with the interests.

Risks of trading with futures

When trading with futures, be aware of the following risks.

Leverage trading involves trading with borrowed funds. To borrow funds from a third party, normally a cryptocurrency exchange, you leave some kind of insurance. This insurance is called “initial margin”, and you have to set these funds aside before opening a leveraged trade. 

If the market goes against you and the trade doesn’t bring a profit, this insurance will be taken by the exchange. Before liquidating the margin, an exchange sends a user a notification that the margin amount is getting low (a margin call). If the among is not filled in, the event of liquidation occurs.

So, futures trading allows you to enter trades with the best assets without purchasing assets. If used correctly, it may deliver significant benefits.