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Ethereum Futures Explained

Explaining Ethereum Futures

May 10, 2021 | 

JOHN K MWANIKI |  0 Comments| 

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Trading futures contracts is whereby the buyer commits to purchase, and the seller agrees to sell the specific asset at a set price on a predetermined future date. So, in Ether futures, the underlying asset is Ether, the second-largest cryptocurrency globally in terms of market capitalization.

Financially settled ether futures

A remarkable thing about the CME Ethereum futures is that it is a financially settled ether futures product regulated in the US. That means, when an ether futures contract expires, it doesn't warrant the transfer of 50ETH to a buyer but an equivalent of the value in dollars. Many traders and investors always look for financial settlements when it comes to such trades.

When considering financially settled futures contracts in the crypto space, it means you have the freedom to avoid the barrier to entry associated with wallets and custody of the wallets. According to Tim McCourt of CME Group, some institutional investors would require various types of insurance of the crypto assets if they sort out their custody solution; therefore,  a financially settled Ether futures product simplifies things for many people. 

A financially settled Ether futures contract depends heavily on a strong reference rate for the prices while removing the need to go through Ethereum, the underlying blockchain behind Ether. The only influence the Ethereum technology would have on the CME Ether futures contracts is if its technical upgrades, notably ETH 2.0 and its issuance schedule, affect its listings on the five main exchanges. The exchanges are where CF Benchmark outsources the data for CME to calculate its dollar reference rate.

However, just as ETH2.0 is vital for the technical advancement of Ether, a financially settled ether futures product is essential for the market growth of Ether.

How do ether futures work?

With Ethereum futures, rather than having the seller deliver the underlying Ether when the contract expires or on the settlement date, the contracts are settled for cash. Suppose the settlement price of Ether ends up at a higher value than the contract price, the seller commits to compensating just the dollar difference between the contract price and the settlement value. On the other hand, if the settlement value is lower than the contract value, the buyer commits to pay the other party or seller the difference.

The next question on your mind is quite obvious, what price do they use? The futures contract monitors the price of Ether via the CME CF reference rate for ether/dollar (ETHUSD-RR). The platform also pulls 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, every contract translates to 50ETH and is priced in the major currency, the US dollar. CME Globex, the exchange's electronic trading platform that operates 24/7 to support traders from all parts of the world, has a maximum order size of a hundred contracts. Regardless of the price of Ether on the contract's expiry date, both parties should hold their end of the bargain to buy or sell the contract.

A good example

At the beginning of March, Alice is bullish on Ether and believes that its value will increase in the next four weeks. On the other hand, Bob is bearish on Ether and believes that its value will fall by the end of the month. So both parties get into an Ether futures contract on CME.

Alice commits to purchase one ether futures contract with an expiry date of 30th April. Ether's value is at $1800; therefore, the contract's notional value is $1800x50=$90000. Then Bob commits to selling one contract of Ether on the same date, 30th April.

In this case, Alice believes and hopes that Ether will increase in value by the end of April to profit from the difference in value between the price of the initial 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. That means the settlement value for the ether futures contract is 50x$2000=$100,000. Here, Bob has to compensate Alice $100,000 as part of the ether futures contract, leaving Alice with a $10,000 profit.

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 has to pay Bob $90,000 for a contract worth $80,000, leaving Bob with a $10,000 profit.

Why Ethereum futures matter

According to James Putra, VP Product Strategy at TradeStation Crypto, the opening of ether futures trading on CME, one of the largest derivatives exchange platforms, is beneficial for attracting new institutional investors into the market. He further added that many institutions are ready to gain exposure into the crypto market but cannot access the spot market, so they need the futures market.

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

As Putra puts it, futures give traders long and short optionality, so they don't have to wager against only one side, unlike the spot market where traders are limited to long-only, that is, buying and holding.

Additionally, futures are a vital step in the growth of markets, paving the way for other sophisticated products for investors and traders to leverage. The increasing interest in Ether futures products reflects the growing interest in what Ethereum is building, including ETH 2.0, de-fi, and stable coins.

CONCLUSION

By trading Ether futures contracts, you stand to benefit from Ether's future price movements, get into the crypto market without having to pass through unregulated crypto exchanges or establish crypto wallets, and you can also use leverage to boost capital efficiency.

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