Bitcoin Futures: What Are They and How Do They Work?

And were off! The Chicago Board Options Exchange (CBOE) launched Bitcoin futures Sunday night (December 10), trading under the ticker XBT. By this time next week, the Chicago Mercantile Exchange (CME) will have launched their Bitcoin futures product (December 18, officially), and Nasdaq will also begetting in on the action early next year. In short, bitcoin futures have arrived and the investment communitycant stop talking about them.

Before addressing the impact of this major milestone for bitcoin and speculative investors, heres a quick refresher for those unfamiliar with futures contracts. Futures are a derivative product – a standardized contract to purchase or sell a commodity (such as gold, silver, oil) or a financial instrument (bonds, the performance of the S&P500 and now bitcoin) at a specified price at a specified time in the future.

Some futures contracts may call forphysical deliveryof the asset, while others are settled in cash. The value of a futures contract is derived from the value of the underlying asset.The vast majority of physical delivery futures contracts are never actually delivered – the buyer or seller rolls them into another contract.

How do investors purchase futures contracts?

To purchase futures, investors need to go through a futures commission merchant (FCM), a regulated entity that accepts orders for futures contracts. This is a different kind of account than your usual cash equity brokerage account, but the basic idea is the same. Margin must be posted to the FCM in advance of buying or selling and a minimum margin amount must always be maintained. A daily settlement process occurs, whereby the future is valued relative to the original transaction level. Futures provide a significant amount of leverage, so they need to be used responsibly – investors need a certain level of experience, expertise and capital to trade futures.

The launch of bitcoin futures will be the first time weve seen real exposure to bitcoin as part of a mainstream, highly regulated investment product – and because of this, futures are the first step in incorporating bitcoin into our existing investment ecosystem.

In Canada, until now, if you wanted investment exposure to bitcoin, the only choice for retail investors has been to find an unregulated cryptocurrency exchange, and purchase bitcoins through these exchanges with cash. For accredited inventors, there are a few trusts that have been previously launched around the world.

In 2014, the Mt. Gox exchange was hacked, leading to the theft of $473 million (US) worth of bitcoin – just imagine what that would be worth today. In 2015, storage wallet Bitstamp was hacked, resulting in the theft of $5.1 million (US) worth of bitcoin. In 2016, $72 million (US) worth of bitcoin went missing after Bitfinex was hacked. And these are just a few cases.

The fact of the matter is, unlike most things related to bitcoin and other cryptocurrencies, futures contracts are well understood in the investment community. While there is a perceived level of risk, trading futures may provide exciting rewards when used effectively.

Aside from the underlying holding being tracked, the structure of the CME bitcoin futures contract should be very similar to other CME futures contracts. Bitcoin has shown a significant amount of volatility to date and I would expect that will continue. CME bitcoin futures will have position limits and circuit breakers where trading is halted at +/- 7% 13% and not allowed to trade +/-20% from the previous settlement price (whichoccurred multiple timeswithin the first 24 hours of CBOEs futures contracts trading). This makes them ideal tools for other investment products to track.And that process is already underway.

What other bitcoin investment products are available for Canadian investors?

In September,Evolve ETFs filed a preliminary prospectus with Canadian securities regulators for Canadas first bitcoin exchange traded fund. If approved by regulators, this new ETF would track bitcoin futures, rather than holding the cryptocurrency directly.

Its an exciting time to be an investor, with potential access to new and exciting investment opportunities related to bitcoin.

Kirk Cooper is Chief Investment Officer at Evolve Funds