The cryptocurrency market has come a long way since its inception in the late 2000s, opening the door to the emergence of the first cryptocurrency exchange companies and triggering a movement typical of emerging markets.
The recent sharp fall in the bitcoin exchange rate has had a major impact on the cryptocurrency derivatives market. When the price of the world’s most valuable cryptocurrency reached a record high in early 2021, few imagined that bitcoin futures would go into decline shortly thereafter.
In this article, you will find out what bitcoin futures are and how backwardation is affecting the cryptocurrency market. You will also find out whether it is better to buy bitcoin long or take a long position in bitcoin.
Understanding Cryptocurrency Derivatives
Derivatives are contracts that involve a buyer and a seller. The parties agree to exchange a financial instrument at a fixed price on a specific future date in order to fulfil the contract. There are different types of derivatives such as futures, swaps and options. Futures are derivative contracts secured by financial assets . The price of a futures contract is therefore based on an indicator of the price of the asset at a future date. Futures are generally used in the financial market for three types of transactions: hedging, speculation and arbitrage.
Bitcoin futures prices
In general, bitcoin futures prices are always reflected in an index of the best bitcoin brokers on the market. However, some additional factors are taken into account when calculating the futures price.
The maturity date is the date on which the futures contract expires and the asset is to be delivered. Each contract has a specific maturity date. The later the maturity date, the higher the price of the contract. The risk-free rate of return is the benchmark rate of return in the economy.
Contango vs. backwardation
Given these factors, it is likely that futures contracts will have a higher price than a money market asset. When this happens, we say that the market is in a contango situation. Anyone who buys a futures contract has to pay a premium for the difference between the price of the futures contract and the spot market price.
However, there are cases where the futures price is lower than the price on the cash market. If the price curve shows such a trend, we can say that the market is lagging.
Bitcoin derivatives in the 2021 market
Although the price of bitcoin dismayed investors and fell by 20% to a six-month low, expert evidence suggests that derivatives played a negligible role. Instead, the massive sell-off can largely be attributed to the capitulation of Chinese miners, who were forced to suddenly halt their operations
Typically, bitcoin futures are traded in healthy markets at a premium of 5-15% per annum. The worst was on 22 June, when this premium reached a low of 2.5%, which is low, but not enough.
Though Bitcoin futures trading has recently gone through a period of backwardation, expert data does not show current signs of long position stress or a potential downside swing caused by crypto derivatives markets. But still many traders point to the pullback as a bearish signal and it is crucial to note that trading derivatives involve significant financial risks.