Are Perpetual Bitcoin Futures Good or Bad?

The current and very impressive Bitcoin rally is a tribute to the staying power of the senior cryptocurrency. However, there are parts of the puzzle that do not have to do with the virtues of Bitcoin. Rather they are products of tools and strategies used in the cryptocurrency trading world. One of the aspects of the Bitcoin rally is the use of perpetual Bitcoin futures. The use of perpetual Bitcoin futures may be good or bad depending on the situation.

What Are Perpetual Bitcoin Futures and Why Use Them?

Futures are derivative contracts in which one promises to buy or sell an asset at a specified price on a specified date. These contacts are used for commodities ranging from corn and soybeans to crude oil, gold, and coffee. They are also used for stocks and currencies. Futures contracts have specific expiration dates. However, a perpetual future does not. Thus perpetual Bitcoin futures can be held for as long as a trader wants to hold them. Regular futures are settled at contract expiration. Because perpetual futures can, in theory, go on forever, there is the possibility of the contract price diverging widely from the market or spot price. With perpetual futures this issue is handled by using the funding rate mechanism.

Buyers and sellers (long and short positions) make payments periodically based on the current spot price, futures price, and prevailing interest rate. This tends to keep the futures price reasonably close to the spot or market price. It also allows one to stay in a potentially profitable futures position long after a traditional futures contract would have expired.

Advantages of Perpetual Bitcoin Futures

One who trades Bitcoin futures of any futures contract does not have to own the asset represented in the contract. Very often producers or buyers of commodities use futures to hedge their risks. Speculators typically do not own such underlying assets such as Bitcoin. By purchasing a futures contract to buy or sell they leverage their trading capital. Trading correctly in a rising or falling market can result in a far greater return on invested capital than happens when one simply buys and then sells or sells and then buys Bitcoin or any tradable asset.

Risks of Perpetual Bitcoin Futures

The eternal truth in any market is that profit and potential and risk always go hand in hand. This is especially the case with leveraged positions. You gain the right to earn many times as much but also take on the risk of losing many times as much as occurs with simply buying and selling. We wrote recently about what amounts to a crypto leverage mirage that has the potential to distort prices over the short term and the risks that poses for the average Bitcoin investor. To the extent that leverage as caused by perpetual Bitcoin futures causes the price of Bitcoin to rise it attracts more investors in spot Bitcoin ETFs which, in turn, drives the price higher. We see now that a fair amount of money is coming out of China as their economy threatens to melt down. While investing in Bitcoin there is banned the opportunity to get into Bitcoin via new ETFs is likely to be very attractive. This is great so long as Bitcoin keeps going up. The recurring worry with Bitcoin is that it is going to overshoot and then correct, painfully.

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