Since the Covid-19 market crash, cryptocurrency derivative markets have seen a huge surge in popularity as speculators try to take advantage of price volatility and trading volume volatility. Despite mediocre trade volume, the range of available markets was increasing significantly in the months leading up to this event. Although bitcoin halving and increased volatility have resulted in a closer alignment between the types of contracts on offer and the range of trading features. A derivative market contributes between 5 and 7 times more capital to the current equity and foreign exchange markets than a spot market. Crypto spot volume still exceeds derivative volume, suggesting that the market cap is likely to increase significantly. While institutional investors dominate the crypto space, the development of crypto futures derivative markets increases the value offering phenomenally and contributes significantly to the market growth needed to position digital assets alongside major traditional markets at a time when institutional investors dominate the space.
Bitcoin Futures Landscape
Several extreme values have been recorded since the development of the BTC Futures Trading market, fluctuating between the two aforementioned positions. As a result of these codependent markets, speculators have been able to accurately determine trends based on distinct patterns in behavior.
A contango Bitcoin futures market encourages big players to sell futures contracts to hedge risks and lock in future asset values. As premiums of US$500+ per bitcoin become commonplace when the market moves into extreme contango, those with substantial holdings will be more motivated to sell off futures. Due to institutional/hedge fund futures contract hedging, extreme contango is normally limited and momentum quickly stalls. Due to this, short-term speculators are some of the only futures buyers, dampening volatility seen since futures markets began.
In contrast, backwardation occurs when investors short aggressively or when a downturn in the futures or spot markets causes liquidations and reverses contango. When a market operates in backwardation, large investors can purchase futures contracts at a discount, closing out their hedges and taking increased profits. Investors can maintain exposure to the spot market by selling their holdings in the spot market and purchasing discounted futures. This structure allows limited periods of backwardation.
As an example, much of the world didn’t know what effect the Covid-19 virus would ultimately have on the markets prior to the Covid-19 crash in March. In the days following February 12th 2020, a number of futures markets entered extreme contango, displaying premium differences in excess of US$500. After peaking at just under US$10,500, Bitcoin spot prices began their downward spiral. One month later, on March 12th, the BTC price fell by 19% and the futures contract price went through a US$400 discount. After hitting a low of just under US$5,000 over the following days, Futures Trading Crypto purchased by large-scale investors led to a rapid recovery.7 This was partially due to a significant increase in Bitcoin futures purchases.
Impact of Futures Market on Bitcoin and its Investors
In the long run, the introduction of bitcoin futures does not impact price much – since long-term value is determined by fundamentals (adoption, use-cases, etc.). In spite of this, futures do strengthen the integrity of the market, since they limit volatility and provide institutional investors with more liquidity. Using this tool, investors can determine market sentiment more effectively and act accordingly, as it provides them with another lens to analyse the bitcoin market. In addition to allowing for wild speculation, it also assists in price discovery, as shown above. The introduction of derivatives into the bitcoin market was a positive move that ultimately solidified bitcoin’s financial framework. A number of access points have allowed investors to treat Bitcoin holdings like traditional investments by increasing market capitalisation and trade volume. As a result, bitcoin becomes a more popular investment option and attracts more interest.