What are futures?
A futures is a derivative contract to buy or sell an asset at a specific date and price in the future. It’s called a derivative because it derives its value from the underlying asset.
A futures contract has its own market with demand and supply, i.e. it has its own price.
- If the price of the futures is higher than the spot price of the underlying asset, the market is in contango (that's us! 💃).
- If the price of the futures is lower than the spot, then the market is in backwardation.
In TradFi, futures are traded on many different assets such as currencies (EUR, USD, etc.) or commodities (wheat, oil, etc.), either for speculation or for hedging purposes. In crypto, futures are normally traded on cryptocurrencies (BTC, ETH, etc.). See the use cases section for more details.
Just like in TradFi, futures contracts on cryptocurrencies have:
- a price at which they can be bought and sold.
- an expiry date, at which the underlying asset is exchanged between the parties (physical delivery).
When buying or selling futures, traders can make use of leverage, i.e. borrowed capital to make trades. Leverage allows traders to amplify their buying and selling power, but it also increases the risks of liquidation.
Let’s say the spot price of ETH in January 2022 is
The sentiment is optimistic so the market is currently in contango: the futures price of ETHDAI is
A trader believes the price of ETHDAI will go up over the next few months. So she buys (goes long) 1 ETHDAI March 22 futures contract, at
In March, at expiry, the trader will receive 1 ETH for the original price paid of
, regardless of the ongoing spot price
If, as expected, ETHDAI appreciates even more to
and the 1 ETH is sold for DAI then she makes a profit of
If, on the contrary, ETHDAI goes to 100 then, by selling the 1 ETH, she realises a loss of
Futures are 🔥. They’re older than currencies. It seems it all started in 1750 BC with the Hammurabi Code which allowed ancient Babylonians to enter into contracts for future delivery of goods. Later the Japanese perfected the idea of a futures exchange with the Dojima Rice Exchange, born in 1730. And in the modern era it was the Chicago Mercantile Exchange that brought futures into the mainstream, with futures trading on foreign currencies (source: Investopedia).
Flash forward to today’s crypto world: Bitmex, Binance and other major exchanges all offer futures trading on many pairs.
Check out the next section to see why we need expirable futures and why Contango is the market leader in the space.