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Bitcoin Futures Getting Started: On the origin of futures, behind the scenes and principles

Son said: "It is therefore old and new."

There is a common characteristic between Confucius and Nakamoto: no one knows whether their best-known works were created by one or more people.

No matter who made the above quote, this is a suggestion from a Sage, so to understand what the meaning of cryptocurrency introduced by Chicago Board of Exchange is, let us start with history.

As early as the "futures" contract, the transaction there is a "forward" contract. Prior to the appearance of a forward contract, the transaction was made through a gentlemen's agreement (the agreement between the parties, signed only in words, only by verbal commitment or exchange of letters). Before the gentlemen's agreement, the deals simply "show off your harvest on the market and hopefully they will be sold at the price you want."

The above four forms of trading still exist today.

"Show off your harvest in the market and hopefully they will be sold at the price you want." It goes without saying. The other side of the deal is "I hope that the merchants on the market can sell you what you want at the price you want." The problem with trading in this way is that, besides just verbal promises, The risk of losing money by matching counterparties. In order to solve this problem, a gentleman's agreement appeared.

In the gentlemen's agreement, the two counterparties agree on the timing, place and price of the future before trading. The problem with the gentlemen's agreement is that both counterparties are willing to abide by the agreement.

The default of one or more of the necessary counterparties usually causes litigation.

However, the courts often ignore these cases because it is hard to convince judges that you and your counterparts had "taken pictures" of handshakes together. (Well, when they might not call them "self-portraits", but you understand) In order to solve this problem, forward contracts have emerged.

Forward contracts are legally binding agreements between two counterparties to trade a given asset between the future (forward) and a given price. If one party fails to fulfill the agreement, it allows the other party to seek the court's assistance. Although signing a contract is much better than smoother selfies with two people, it has one problem: the defaulting party may go bankrupt. As the default side generally do not pay off the debt, the other party is actually losing money.

In order to solve this problem, people have developed futures contracts.

 Futures contracts are almost the same as forward contracts, with a slight difference. The main difference is that the exchange acts as a guarantor on both sides of the transaction.

Bitcoin futures contracts to be launched on the Chicago Mercantile Exchange on December 18 are cash-settled contracts. This means that at the expiration date, the actual bitcoin will not be traded, but at the final settlement price, cash will be credited to one of the accounts.

If the contract traded for the first time at $ 12,000 and the CME bitcoin index reached $ 14,000, the seller would have to make a whopping $ 2,000. If the seller decides to run and fails to fulfill the contract, the exchange intervenes and protects the buyer's equity.

Of course, the exchange does not provide free services, which is to charge a transaction fee.

Charge chain

The Exchange charges part of the "transaction fee", which of course is to be expected. But this is another story, the exchange did not really assume all the risk of default.

They also have other entities known as "futures clearing houses" at most risk. Settlers also charge fees from services they call "settlement fees."

Exchanges must be regulated, after all, they are basically counterparties to every transaction now. In fact, they can default on their own.

In the United States, they are subject to the regulation of the Securities and Exchange Commission (SEC) of the Commodity Futures Trading Commission (CFTC), although the latter includes the term "exchange". Why these government agencies are separate may be a good topic for a new essay.

But this is a fun thing. The CFTC is the regulator of the futures exchange, but it basically outsources much of its work to the National Association of Futures Agencies (NFA), a self-regulating association established by the exchange. Similarly, NFA people do not provide free services, which is to be charged.

For Bitcoin futures, the CFTC Ginseng wash only relies on the self-regulation of exchanges and NFA and the self-discipline of the Bitcoin futures market.

Remember I said that the exchange does not bear all the risks, they have a settlement company at risk? Then the settlement company is not a fool, and they also pass some of the risk to the company called introduction broker. Introducing brokers, of course, to charge "brokerage fees."

Firmly controlled

Now if you think brokers are the last fools, think again, the last part of this chain is you who acts as a trader.

Yes, do you think it is because you paid the transaction fee + settlement fee + NFA fee + brokerage fee to make you out of the mess? Ha ha ha, laugh I roll, let me slowly.

All right. When the exchanges said they would act as guarantors for both parties, what they really meant was that they would ask their friends (sometimes a subsidiary of the exchange, not to be confused with the settlors) to put their hands in the pockets of both parties on a daily basis, To ensure that when the market is not good for them, they will not abscond.

You may be able to trade anonymously in Bitcoin cash market, but you can not trade anonymous futures.

So if two counterparties trade bitcoins for $ 12,000, the settlement organization will calculate the value of the contract daily with a "settlement price." For CMEs, the settlement price is determined by the bitcoin reference rate (BRR). BRR is calculated using the market prices of some exchanges.

As of now, the CME index tracks the market prices of the four exchanges: Bitstamp, GDAX, Kraken and itBit. Cboe, which will launch bitcoin futures on Sunday, uses the Gemini exchange. If the settlement price is $ 11,900, after the first day, the settlement organization gets $ 100 from the buyer and gives it to the seller. If the settlement price is $ 12,100, the opposite is true: the settlement organization takes $ 100 from the seller and gives it to the buyer.

Such a market trading process repeated on each trading day.

By doing so, the exchange essentially protects both parties without having to deal with the huge losses that could take days. Billing organizations do not really contact most traders except for self-clearing. They routinely put "hands in their pockets" with their settlement agents. The clearing house notifies brokers and traders who must deposit with the clearing house before the clearing organization withdraws money from the clearing house's pocket.


CME has created a fantastic tool to measure the intraday volatility of every commodity futures contract, which is called SPAN and is an acronym for standard portfolio analysis of risk.

SPAN did some of the same intensive calculations as the Deep Thought machine in the Galaxy Roaming Guide.

Like Deep Thought, SPAN spit out a fantastic number. But in fact, each contract is different. This number is used by many brokerage firms to determine how much risk the trader will bear, which they call Initial Margin. This is the amount the trader must deposit before trading a given contract.

In the case of a completely new contract such as a Bitcoin contract, if the SPAN does not have historical futures data to calculate the amount of margin, the exchange will get a new value from SPAN. For CME, SPAN should get an initial margin of 35%. For CBOE, SPAN draws 30%.

So is this correct? no.

Look carefully at the first word of the word "initial margin." The deposit you deposit is only for the purpose of "initial" trading. If you are quick to start earning money from trading and practicing "buy low and sell high," that is the best.

If your trading strategy does not follow this simple notion and you buy and sell a futures contract and cause the initial margin to fall below a certain value called "Maintenance Margin," then you will receive a call for additional funds. If you do not do this, your broker, clearing house or exchange will close your account and anything left in your account will be used to cover the loss.

The above is a high level overview of the futures market and also explains how account management and setup work. The process is the same regardless of whether the account is for trading oil, wheat or bitcoin.