A futures contract, often just called a future, is a legally binding agreement between two parties to conclude the sale of an asset at a pre-agreed price at a fixed date in the future.
Futures emerged as a way for producers to guarantee a fixed price for their crops; however, in the modern financial markets, they are used as speculative instruments. Traders bet on the future price of an asset, and at the expiration date, the contract is settled in cash, with no physical exchange.
Futures trading takes place on exchanges, where traders buy contracts (also known as “going long”) if they believe the price of the asset will go up and sell contracts (“going short”) if they think it will go down.
A futures contract typically features standard components. Unless it’s a perpetual or open-ended contract (see below), the contract must have a fixed expiration date when settlement takes place at the agreed price. It must also define the lot size or the amount of the asset that the contract represents (e.g., one BTC or one US dollar’s worth of BTC) and how the contract will be settled: with the asset itself or in cash.
Finally, it will also specify any leverage applied. Leverage allows a trader to place larger trades using a smaller amount of collateral and is typically expressed as a multiplier, so 2x leverage means that the traded value is twice the value of the trader’s collateral.
History and evolution of futures in the crypto market
The evolution of futures in the crypto markets has undergone several key milestones. Bitcoin futures first emerged in 2014 as an unregulated offering by centralized exchanges. They became popular as a way of speculating on the short-term price of Bitcoin without needing to handle the operational and security issues around custody.
In 2016, crypto futures exchange BitMEX became the first to launch perpetual futures contracts. Perpetual futures operate in a similar way to futures contracts, except they don’t have an expiry date for the settlement of the contract. Instead, they remain open indefinitely until the trader exits their position. Having no fixed end date, perpetual contracts are settled periodically (typically every few hours) using a funding rate calculated based on the deviation between the spot asset price and the perpetual contract price.
In December 2017, two regulated trading venues – Cboe and CME – both launched a regulated Bitcoin futures offering within a month of one another. Due to the bear market of 2018, Cboe would pull its crypto futures products in early 2019, but CME continues to offer regulated Bitcoin futures to institutional traders to this day.
It’s now just one of many operators offering regulated or unregulated crypto futures, including a small segment of decentralized futures offerings.
One of the first DEXs to launch decentralized futures was dYdX, which developed an on-chain perpetual contract in 2020 and later launched fixed-expiry contracts alongside it. Now, it’s just one of several decentralized derivatives exchanges, including Jupiter, GMX, and Hyperliquid.
In June 2024, open interest in Bitcoin futures hit a record above $31 billion.
Benefits of trading crypto futures contracts
Trading cryptocurrency futures comes with several advantages over trading assets in the spot markets, particularly for high-frequency traders and institutions. First, trading futures via centralized exchanges means there’s no need to take custody of underlying assets, which significantly reduces the complexity involved with digital asset custody, like finding a suitably secure wallet. The trader only needs an account at the relevant exchange.
This reduced complexity makes it easy for traders to quickly enter and exit positions with a low risk of slippage. Further, many futures trading venues offer high leverage, meaning that futures trading can be very capital-efficient. However, it should be noted that trading with leverage is high risk since losses, as well as profits, are magnified.
Since they are attractive for shorter-term, high-frequency traders, futures markets also tend to be highly liquid, further increasing their appeal.
Decentralized crypto futures trading does require an on-chain wallet; however, it still offers similar advantages over on-chain spot trading.
Market impact of cryptocurrency futures
The introduction of crypto futures contracts has created a market with new trading opportunities and generated financial value worth billions of dollars. However, observing their impact on the cryptocurrency market also reveals unintended consequences. One of the most significant is the incentive for manipulation of the underlying spot asset prices – a feat that is easier to achieve in unregulated markets, as cryptocurrencies and DeFi have been for much of the time since the launch of crypto-backed futures products.
Futures exchanges have an information dependency on the price data coming from spot markets, and given the market conditions at the time, with lower market capitalization and relatively lower liquidity, traders would seek to manipulate the price of Bitcoin on the spot markets in order to take advantage of the movement on a futures exchange.
Unfortunately, pre-regulation, it was all too easy for traders of futures in the crypto market to operate multiple accounts pseudonymously and carry out such trades at high leverage. This meant they only had to post a relatively small amount of collateral to execute large-value transactions.
As the crypto markets became more regulated and KYC practice became the norm on centralized exchanges, these types of practices moved to the DeFi markets. However, regulators have now also begun to clamp down on individuals and platforms found to be in breach of established market rules.
One example is the case of Mango Markets, where trader Avi Eisenberg executed a series of transactions designed to artificially inflate the price of MNG tokens so that the protocol would allow him to effectively steal cryptocurrencies worth over $110 million by trading perpetuals with high leverage. In April 2024, he was found guilty of fraud and manipulation and faces a lengthy jail term.
Cryptocurrency futures essentials
- Crypto futures contracts are a type of derivative used to speculate on the future price of a crypto-asset.
- Trading cryptocurrency futures can be advantageous for short-term, high-frequency traders, with high capital efficiency, rapid entry and exit, and liquid markets.
- Digital asset innovation pioneered the development of perpetual futures, contracts without an end date that provide uninterrupted market access.