This post describes what are Futures and their main characteristics. It goes into the differences between a Spot and a Future transaction, then touches on what are the different available maturities and particularly in Futures on Ethereum. It then talks about different type of settlement mechanisms (physical delivery vs. cash settlement) and what is meant by Leverage in Futures. Then finally it outlines what are Futures good for and also when is it best to avoid using them.
TLDR: Futures on Ethereum are actively traded and are Cash Settled. There are usually 4 different maturities available to trade: 1) the Perpetual that roll s every day and therefore never matures; 2) and the next 3 quarterly futures with maturity on the last Friday of March, June, September and December. Advantages of Futures is that they give access to leverage, you don't need to pay Gas to buy, or sell as there is no physical delivery of Ethereum, they are liquid and good choice for short to medium term trading. On the other hand, Future are a poor choice if you need ownership of Ethereum - such as if you are buying to hold - as the Future doesn't give you ownership. Leverage can be a bad thing if you use too much of it, and if you don't understand how futures work then first try trading with paper-money before committing capital.
Disclaimer: Information in this article should not be construed as an advise to trade in Futures, or in Cryptocurrencies. Cryptocurrency is a volatile asset class and Futures compound that by allowing leveraged positions. Also trading does not guarantee a desired outcome and you may lose part, or all of you capital. If you are unsure whether this asset class is for you then please seek professional advise.
What are Futures
Futures are a colloquial term for a Futures Derivative Contract that binds the buyer and the seller to a trade:
- The Buyer of a Future on Ethereum has the obligation to buy Ethereum at a pre-agreed rate in the future, and;
- The seller agrees to sell Ethereum at that price to the buyer. Both parties agree to this trade
A Future is a Derivative Contract for a delivery of an Underlying at a future date. This is important... The delivery is not at the moment when the contract is traded, but rather at a future date.
The term derivative means that it derives its value from something else - the underlying asset on which the derivative is based. So an Ethereum Future, as is commonly referred to, is actually a derivative contract where the buyer agrees to buy Ethereum at a future day.
There are other types of derivatives (e.g. options), but Futures are by far the most common ones. They are simplest ones to understand and the most liquid ones to trade.
What is the difference between a Spot and a Future?
In trading, the term Spot usually refers to something that is traded for immediate delivery (or as soon as technically possible).
When you buy Ethereum in a Spot transaction, you are essentially expecting that the seller will transfer it to your account immediately and that you will be able to see the transaction in your wallet very, very soon. You would normally do this trade on a Spot Exchange (such as Binance, Kraken, Coinbase ...) and not know who the seller is, but would still expect the amount to appear on your blockchain address very, very soon.
When you buy Ether in a Future transaction you are buying it for a future delivery and should not expect that the seller delivers it to you immediately. When exactly in the future the delivery should take place is determined by the maturity of the Future, subject of the next topic.
Note that Futures are a common trading instrument in the fiat currency world and there are futures on a large number of instruments, ranging from Oil to Interest Rates. This is therefore not a new invention of Crypto, but rather an adoption from the fiat world.
Maturity of Futures
The list of available maturities for a Future are to a large extent pre-determined and follow this schedule:
- Daily Futures - aka the Perpetual Futures. These mature every day at 8am UTC and are automatically rolled at maturity for another day - so effectively they never mature due to this rolling effect.
- Quarterly Futures - These maturity on the last Friday of March, June, September and December. And there are usually closest 3 of these available to trade. The closes 3 to today.
Settlement of Futures (aka Delivery)
The Perpetual Futures never settle, but the more conventional, Quarterly Future do settle. A Futures can be settled in two ways:
- Physical Settlement of Futures - which is not very common in Crypto, but this is intuitively something that you might think happens when describing a Future transaction. Physical delivery is more common on agricultural Futures, such as live stock, corn or Oil (interesting fact that due to this physical delivery obligation the Future price of Oil actually went negative for delivery in early 2020 as the Covid19 was unfolding and no-one wanted to get Oil delivered as there was no storage left, so traders were willing to sell Futures on Oil at a negative price just to avoid having to receive delivery). In Physically settled Future the buyer has to take delivery from the seller on the maturity date.
- Cash Settlement of Futures - these are most type of Futures in Crypto trading. Cash Settlement means that on the maturity of the Future the buyer and the seller which check where the price of the underlying asset is versus the agreed price of the Future and one would pay the other the difference. So no physical movement of assets takes place, but only a one-off payment between the buyer and seller on maturity.
To avoid settlement altogether, and avoid paying fees which are commonly charged by the Exchanges for settlement, it is common that traders close their Futures position ahead of the maturity date. In this case the buyer of the Future would sell the same amount of Future therefore reducing their position to zero (and the seller of the Future would buy back the Future).
The fact that Future can be cash settled brings about the possibility of leverage.
Leverage using Futures
Leverage is when you buy more than you can afford or sell more than what you have. In Futures this is possible because you don't actually buy (or sell) anything until a future date. If you buy 100 Future of ETH for delivery in March then you don't buy anything today - you enter into a contract to buy ETH in March at an agreed price. If the price of ETH goes up between now and March and you close your Future position before maturity then you can expect to make a handsome profit (and vice versa if the price goes down you would make a loss). But crucially you didn't have to put any money upfront because you didn't actually buy any Ethereum after all, all you did is enter into an agreement to buy Ether which you then cancelled early.
So, in theory you would have access to unlimited leverage as long as you always predict correctly the direction of the market. In practice, however, this is not always the case. Traders sometimes get the direction wrong and end up losing rather than making money. And when a trader is losing money on a Future trade there is always an incentive to try and walk-away, not to honour the trade. For this reason the Exchanges put a limit on how much leverage someone can take and make sure that the available funds on the trader's account are enough to close the position at any time.
The limits on leverage are usually put in place with two metrics: 1) the Initial Margin and the 2) Variation Margin. How these get derived is fairly convoluted, but in short the Initial Margin is the amount you need to have on account to open a trade and the Variation Margin is the additional amount that you need to have on account as a result of the market moving against you. So if you bought a Future and the price of Ethereum started going down (rather than up as you expected) then the Variation Margin will increase to reflect that you are losing money on the trade and you'll need to have enough cash on account to offset those losses.
So, in summary, Leverage can be a good thing as it allows you take a view on a market in larger size, or sell an asset that you don't have, but you have to be careful to monitor that you always have enough cash on account to cover the Initial and Variation Margins.
Why trade Futures
There many advantages for using futures, the main ones are:
- Leverage - Futures give you the possibility to use leverage and to sell Ethereum that you don't have. This is particularly useful if you think the market is going down and you would like trade on that.
- Cash Settled - When trading Futures you also don't have to worry about settling the Ethereum that you bought, or sold on every trade. Particularly if you are making multiple trades a day. A high frequency trading system might buy and sell thousands of times a day without having to send transactions on every trading (and therefore not pay for Gas). Futures let you settle the profit (or loss) from your account balance - so if you did a trade that lost you money then this amount would just get deducted from your account.
- Fast Capital Turnover - Futures let you get in and out of a position very quickly, partly due to the previous two points. And as a result you can turnover you available capital multiple times a day. For example using a High Frequency Trading strategy and trading just $1 per trade it is feasible to turn over $10,000 in a day.
- Access to Options - Options are traded on Ethereum that give the buyer the right, but not the obligation to buy Ether at a agreed price and at an agreed Future date. And these trade on the same exchange where the Futures trade. So starting to trade Futures is a step closer to being able to trade Options.
When not to trade Futures
Futures do not give you ownership of an asset. When you buy a Future you will not receive an asset at maturity (Ether futures are cash settled and there is no physical delivery).
- If you need to own an asset, then would normally be better done on the Spot market and not using a Future (that doesn't give you ownership of the asset)
- Leverage is good when you get the direction of market right, but also very dangerous when you get the direction wrong. A rough example: If you started off with $100 of capital and bought $1,000 worth of Ethereum using a Future - then it is enough for the price to drop by 10% for you to lose all your capital. This would have been a 10x leveraged position. Exchanges, however, allow for leverage up to 50x, so in a similar example with $100 in your account you could buy $5,o00 of Ethereum using a Future, and would get wiped out if the price of Ether dropped by just 2%. Considering that the volatility of Ether as a rule-of-thumb is about 3% a day, this means that should you ever consider making use of the 50x leverage then there is very good chance of getting wiped out during the day.
- If you don't understand how Future work then don't use them. Always try it them out for a long enough period or time (at least 3 months to see a broad range of market dynamics) with paper-money before committing actual capital.
Futures on Ethereum are actively traded and are cash settled. There are usually 4 different maturities available to trade: 1) the Perpetual that roll s every day and therefore never matures; 2) and the next 3 quarterly futures with maturity on the last Friday of March, June, September and December. Advantages of Futures is that they give access to leverage, you don't need to pay Gas to buy, or sell as there is no physical delivery of Ethereum, they are liquid and good choice for short to medium term trading. On the other hand, Future are a poor choice if you need ownership of Ethereum - such as if you are buying to hold - as the Future doesn't give you ownership. Leverage can be a bad thing if you use too much of it, and if you don't understand how futures work then first try trading with paper-money before committing capital.
Futures characteristic on Deribit Exchange: Link
This article was written and edited by Dmitry Shibaev of Dynamic Strategies