With all the financial jargon out there, sometimes it’s difficult to keep track of what’s going on and what everything means. Today we’re going to take a look at futures contracts, one of the classic financial instruments for investing. Though futures started in the traditional commodities markets, they’re now in use in the crypto markets too! You may have heard of bitcoin futures before now that they have a place in the market. Additionally, Crypto Facilities recently announced the first ever ether (ETH) futures contracts. Let’s take a look at what they are, how they work, and why you should know about them!
‘Futures’ vs ‘Futures Contracts’
To start things off, we’ll mention that these two terms are essentially the same. ‘Futures’ is typically used as a shortened or simplified version of ‘futures contracts,’ though sometimes there is a difference. For example, if we’re talking about the market someone’s trading in, we might says he’s trading in the ‘futures markets.’ On the other hand, ‘futures contracts’ would then the item actually being traded. Just know that if you’re hearing these two terms, they’re really referring to the same thing.
What is a ‘Futures Contract’ (Simplified)?
The concept itself is actually rather simple. And since we’re all about explaining complex crypto and financial topics is plain-English here CryptoLearningAcademy, we’re going to keep it that way! Futures contracts really boil down to a question about volatility. When purchasing bitcoin (BTC), ether (ETH), or any other large cryptocurrency, we all know that the price can fluctuate a lot.
Just looking at the total amount of growth by market capitalization on 2017 shows that quite clearly. However, sometimes investors want to minimize their exposure to price volatility. So what do they do? Sign a contract. Seriously, it’s that simple.
Looking at the current price of BTC (at time of writing, that’s $8,109), an investor (let’s call him ‘Investor A’) might want to purchase more BTC next Thursday but is afraid the price is going to go up over the next week. On the other side of things, we have someone holding BTC (let’s call her ‘Investor B’). Investor B is holding BTC but she thinks the market may decline a bit more over the next week. Investor B has two options: 1) She can sell her BTC now before the price changes again or 2) She can opt-in to a contract with Investor A for next week.
Since Investor A has no issues with the current price of BTC, he’s fine signing a contract agreeing to purchase Investor B’s BTC next Thursday at whatever price the two agree on. That means that by next Thursday, regardless of what price BTC is trading at, the two investors conduct their transactions at the agreed upon price.
Risks and Thoughts to Consider
Above is a very simplified version of what’s really going on in futures contracts, but it should give newcomers an idea of what exactly these investment contracts are. There are a lot more things to consider when trading futures contracts like the brokers involved and methods for determining what value the contract should be set at. However, the core concept remains the same.
Futures contracts often seem confusing to newcomers in the markets, but they’re really relatively straightforward. However, there are additional risks to take into consideration. Investors actively participating in futures contracts are always looking to mitigate risk, and one of the things investors want to cut down on is risk associated with volatility and price movement. Futures contracts don’t guarantee a no-risk investment situation. If the price of an asset drops during the period before your purchase, then you’re still on the line to purchase that asset at the agreed upon price. In fact, you’re contractually obligated to (as the name implies).
Hopefully things are a little easier to understand now! With more futures contracts being introduced into the cryptocurrency markets all the time, it’s worth knowing.