In this world, global financial markets are among those industries that are generating massive profits. People may have a different opinion, but it is crucial to consider how financial markets proceed with instruments for fundraising (capital), getting supplies at meager rates, and making credit out of nowhere. Derivative trading is one of those interesting concepts. Contrary to spot trading, derivative trading is more elastic and controllable because it derives its price from an underlying asset. Crypto derivatives utilize the concept of leverage. You can learn more about bitcoin trading through this link.
Typically, derivative trading means a mechanism in which the traders get into a contract to trade an underlying asset at a pre-determined price and date. The main objective of derivative trading is to predict the future prices of the underlying asset, enabling traders to earn profits resulting from price differences. It can be applied to multiple assets, commodities, paper money, and digital money or cryptocurrency as well. Bitcoin Futures is the most usual type of cryptocurrency.
What Is Derivative Trading?
A derivative is known as a contract that derives its value from the underlying asset. Derivatives assets include currencies, commodities, stocks, and exchange & interest rates. The parties to such a contract i.e. buyers & sellers go against the speculations related to future prices. Both parties bet on the future prices of underlying assets for profit-making.
Derivative Trading In Crypto
Derivative trading also works in the case of cryptocurrencies, and any of the digital tokens/coins can be used as an underlying asset. The buyer and seller that form a financial contract predict the future value of a cryptocurrency on a coming date. At the beginning of the contract, the parties to the contract agree to trade at the price of the cryptocurrency on the following day, regardless of market prices. Consequently, investors can earn profit from the differences in prices of the underlying asset by buying the currency at a lower price and selling it later on higher price.
Types Of Crypto Derivative Trading
Future contracts provide the right to buy or sell cryptocurrencies at a predetermined price & date in the future. Most of the time crypto traders close their future contracts before the maturity of the contract getting their profit/loss in the procedure. Generally, crypto traders utilize future contracts for hedging their investments when trading in a highly fluctuating market like crypto. For instance, if a trader believes that the prices of Bitcoin – the most valuable cryptocurrency tradable via Bitcoin Trading Software will decline after a certain limit, he would utilize a futures contract to hedge his investments.
These contracts resemble futures. However, a forward contract is distinct due to OTC (Over-The-Counter) factor, which indicates that crypto traders (buyers & sellers) can customize the contract. Despite the elasticity, traders should know that lack of centralization makes the forward contracts riskier.
Options are derivatives that enable crypto traders to buy & sell cryptocurrencies (coins/tokens) at a given price when the maturity period expires. An option contract contains no obligations. It can be sub-divided into two types:
● Call Option
A call option provides the right to buy a digital asset at a given price and date.
● Put Option
It provides the right to sell an underlying cryptocurrency at a specific price and time.
For instance, if a trader decides to purchase a Bitcoin at 10,000 dollars, even though the crypto market is extremely volatile in nature. The trader then opts for call options and locks in 1BTC for 10,000 dollars. When the contract expires, and the price of 1BTC has become 20,000 dollars, he has the right to buy or sell 1BTC at 10,000 dollars because the rate is predetermined, and he will earn 10,000 dollars as net profit.
4. Perpetual Swaps
Perpetual derivatives are similar to futures but with an additional benefit of no expiry. In the case of swaps, both the parties agree to exchange their cash flows at a later date. Swap contracts also operate with the Over-The-Counter formula.
Advantages & Disadvantages Of Crypto Derivatives
- It charges a lower commission.
- Derivatives act as a shield against volatility.
- Ability to diversify the risk.
- Crypto derivatives can lead to massive losses.
- It is impossible to regulate some of these derivatives everywhere since they are not considered legal in some regions.
- There is a lack of due diligence in OTC derivatives.