Why Investors Are Increasingly Opting for Bitcoin Futures

The volume in trading bitcoin futures has been steadily rising since both the CME Group and Cboe Global Markets launched their futures contracts in December and as prices in physical trades of the digital asset stabilized.

Volume at the CME rose exponentially to 6,739 contracts on July 5 for the July contract, which is equivalent to $220 million. The average daily volume is typically 2,800 contracts, but by the next day, volume for the July contract dipped back down to 2,253 contracts.

The spike in volume was unusual and the second-highest experienced by the CME, but there was no apparent reason for the climb since bitcoin prices have been stable and not been surging, says Mati Greenspan, a senior market analyst at eToro, a Tel Aviv-based social investment network. On April 25, the CME reported 11,202 BTC contracts.

[Read: What You Need to Know About Bitcoin and Cryptocurrency.]

The futures contracts for bitcoin were launched by both the CME Group and Cboe last December as interest in the cryptocurrency rose and as institutional investors sought a method to hedge against their risk. The first bitcoin futures contract was launched by the Cboe and trading began on Dec. 10 as XBT, which is a U.S. dollar-denominated, cash-settled futures contract based on the auction price of bitcoin on the Gemini digital currency exchange.

A week later, the CME Group began trading its first bitcoin futures contract, based on the CME CF Bitcoin Reference Rate (BRR) that aggregates bitcoin trading activity across major bitcoin spot exchanges between 3 p.m. and 4 p.m. London time.

"We see continued growth both in terms of the average daily volume and open interest," said Tim McCourt, group global head of equity products and alternative investments at the CME Group, a Chicago-based derivatives exchange. "The volume has steadily increased compared to when it was first launched in December. This is not a one-sided product because we have both supply and demand."

Trading futures contracts compared to the "spot market" of bitcoin can be an advantage for traders since it's an efficient asset to hedge the price of bitcoin as it rises and falls, he says.

"Customer demand is strong because the relationship between the futures and cash market have a tight basis spread," McCourt says.

The cryptocurrency market, which consists of bitcoin and other virtual coins such as ethereum, ripple, litecoin and monero, faced extreme volatility and lost a minimum of $350 billion in value year-to-date due to orders from regulators and hacking. Losing billions of dollars in market cap for cryptocurrencies is not unusual. In December, bitcoin reached a high of $20,000, but dipped to $8,500 by mid-March and is now trading at $6,300.

[Read: What's the Best Bitcoin Wallet?]

Bitcoin futures are attracting investors globally with about 30 percent who live outside the U.S. and consists of 14 percent from Asia and 17 percent from Europe based on participation and daily volume year-to-date, McCourt says. The monthly measure of average daily volume for the contracts hit a high of 4,000 contracts for May.

"This is a unique liquidity pool and the risk is being transferred," he says. "This is an efficient tool for price discovery. There are multiple strategies for risk management that are helpful to investors seeking a tight bid-ask spread."

The bitcoin futures contract is more stable since investors have greater liquidity because it is backed by an exchange, says Andrew Wilkinson, chief market analyst at Interactive Brokers Group, a global electronic broker in Greenwich, Connecticut.

"Compared to the spot market, the bitcoin futures market has less volatility and is slightly more organized," he says. "The luxury of the futures market is that you can take advantage of price movements and there is better price transparency."

One of the largest disadvantages of trading futures is that the market can lack both liquidity and enthusiasm and investors do not have the option to get out of a long position when prices are falling, Wilkinson says.

The Cboe contract is better designed because it has a smaller contract value, resulting in a lower margin requirement.

Much of the original fervor of trading bitcoin futures has declined, but the "more it comes down, the more people will be drawn to it," he says.

"Falling prices are attractive to some investors," Wilkinson says. "People thought bitcoin would rise on an unlimited basis, but that story has gone away. The landscape will become clearer as we get near the first anniversary."

Trading bitcoin itself allows investors to capture the upside because that type of movement will not occur with a futures contract, Wilkinson says. In the futures market investors have the ability to go long or short and take directional views.

"Coin investors or enthusiasts typically believe cryptocurrencies will only ever appreciate," he says. "Futures traders are often ambivalent and will trade both sides of the market. Bitcoin futures not only allow investors to get long but also to take short, medium or long-term views that prices may come down."

Wall Street and traditional asset managers are interested in cryptocurrencies as a way to hedge against systemic risk, Greenspan says.

[See: 9 Ways to Invest in Red-Hot Tech Stocks.]

"This isn't comparable to other markets since what is unique about cryptocurrencies is that you can transfer ownership from peer to peer in a short amount of time and receive the actual asset," he says. "Settlement happens instantaneously and allows people to trade in a more free environment while the futures contracts are for institutional buyers."

Bitcoin and other digital currencies are very volatile and extremely unconnected to the rest of the markets.

"It is a powerful ingredient -- just a drop of 0.25 percent or 2 percent into another well-balanced portfolio," Greenspan says.

Ellen Chang is a contributing financial writer for U.S. News & World Report. She is a freelance journalist who is based in Houston and writes articles for TheStreet and other publications. Chang focuses her articles on stocks, entrepreneurs, personal finance, energy and cybersecurity. Her byline has appeared in national business publications, including CBS News, Yahoo Finance and MSN Money. Follow her on Twitter.