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Ethereum Futures Explained

Explaining Ethereum Futures

November 24, 2021 | 

1680 Views | 

Jesus Guzman | 

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When trading futures contracts, the buyer agrees to buy and the seller agrees to sell a specific asset at a specific price on a predetermined date in the future. In the case of Ether futures, the underlying asset is Ether, the world's second-largest cryptocurrency by market capitalisation.

Financially settled Ether futures

What makes CME Ethereum futures special is that they are the US regulated, financially settled Ether futures product. This means that when an Ether futures contract matures, it is not guaranteed to transfer 50ETH to a buyer, but a dollar equivalent. Many traders and investors always look for financial settlements in such trades.

When considering futures contracts with financial settlements in the crypto space, you have the freedom to avoid the barriers to entry associated with wallets and custody of the wallets.

According to Tim McCourt of CME Group, some institutional investors would require different types of insurance for crypto assets when choosing their custody solution; therefore, a futures product with financial settlement for Ether simplifies things for many people.

A financial settlement futures contract for Ether relies heavily on a strong reference rate for prices without the need to use Ethereum, the underlying blockchain behind Ether.

The only impact Ethereum technology could have on the CME's Ether futures contracts is that the technical upgrades, particularly ETH 2.0 and the timing of the issuance, will affect prices on the five main exchanges. The exchanges are where CF Benchmark outsources data for the CME to calculate its dollar reference price.

But just as ETH2.0 is essential for the technical advancement of Ether, a financially settled Ether futures product is essential for Ether's market growth.

How do Ether futures work?

With Ethereum futures, the seller is not obligated to deliver the underlying Ether at the expiration of the contract or on the settlement date; instead, contracts are settled in cash.

Assuming the settlement price for Ether is higher than the contract price, the seller agrees to settle only the dollar difference between the contract price and the settlement value. If, on the other hand, the settlement value is lower than the contract value, the buyer agrees to pay the other party or the seller the difference.

The next question that arises is obvious: what price do they use? The futures contract monitors the price of Ether via the CME CF Ether/Dollar reference rate (ETHUSD-RR).

The platform also receives data on Ether prices on major exchanges, including Coinbase, Gemini, Kraken, BitStamp and itBit. It then calculates a volume-weighted average price for Ether every day.

Basically, each contract is equal to 50ETH and is priced in the main currency, the US dollar. CME Globex, the exchange's electronic trading platform that operates around the clock to support traders from all parts of the world, has a maximum order size of one hundred contracts.

Regardless of the Ether price on the contract's expiration date, both parties should hold up their end of the bargain and buy or sell the contract.

A good example

In early March, Alice is bullish on Ether and believes its value will rise over the next four weeks. Bob, on the other hand, is a bearish speculator and believes Ether's value will fall by the end of the month. So both parties enter into an Ether futures contract on the CME.

Alice commits to buying an Ether futures contract with an expiry date of 30 April. The value of Ether is $1800; therefore, the notional value of the contract is $1800x50=$90000. Then Bob commits to sell an Ether contract on the same day, 30 April.

In this case, Alice believes and hopes that Ether will increase in value by the end of April to benefit from the difference in value between the price of the original contract and the settlement price. On the other hand, Bob also hopes that the price of Ether will fall so that he can profit from the difference.

Case 1: The contract expires and the price of Ether is $2000 per coin. This means that the settlement value for the Ether futures contract is 50x$2000=$100,000. In this case, Bob has to compensate Alice $100,000 under the Ether futures contract, so Alice makes a profit of $10,000.

Case 2: The contract expires and the price of Ether has fallen to $1600 per coin. The settlement amount of the Ether futures contract is 50x$1600=$80,000. Based on the contract agreement, Alice must pay Bob $90,000 for a contract worth $80,000. Bob, therefore, makes a profit of $10,000.

Why Ethereum futures are important

According to James Putra, VP Product Strategy at TradeStation Crypto, opening trading in Ether futures on the CME, one of the largest futures exchanges, is beneficial in attracting new institutional investors to the market.

He added that many institutions are willing to get involved in the crypto market but do not have access to the spot market, so they need the futures market.

Ethereum futures are very beneficial because they allow Ether investors and traders to hedge against future price fluctuations. They are also an important tool for price discovery by market participants.

As Putra says, futures offer traders long and short options, so they do not have to bet against only one side, unlike the cash market, where traders are limited to long-only, i.e. buy and hold.

Moreover, futures are an important step for the growth of the markets and pave the way for other sophisticated products that investors and traders can use. The growing interest in Ether futures products reflects the growing interest in what Ethereum is building, including ETH 2.0, de-fi and stable coins.

Ethereum Futures Market Overview Final Words

By trading Ether futures contracts, you can profit from the future price movements of Ether, enter the crypto market without having to pass through unregulated crypto exchanges or set up crypto wallets, and you can also use leverage to increase capital efficiency.

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