The cryptocurrency system has been rising rapidly in today’s fast world. This medium of money exchange is much cheaper and far faster than other forms of transactions. Since there is a rapid growth of cryptocurrencies, traders have made use of derivatives to control the movements of digital assets.
Crypto derivatives are tradeable financial instruments that obtain or collect their value from their elemental crypto assets. In much simpler words we can say that they are the contract between two traders(a seller and a buyer) who place their bet on their deliberations regarding the price movements of crypto tokens. The trader thereby makes a profit or loss depending on the increase or decrease of the asset price.
There are cases, where these contracts may be met with high risk and involve high-return strategies. Crypto derivatives are commonly used to know the future price movements to make a profit and to be able to control a huge asset using a small amount of money.
Types of Crypto Derivatives
There are many derivatives available in the crypto market. In this section, let us take a look at some of the most common types of crypto derivatives.
Crypto future contracts
This type of contract is when two traders that is the buyer and the seller fix a date in the future to buy and/or sell an underlying asset like cryptocurrencies. The buyer is required to buy the item when the contract expires, and the seller is required to sell the asset. The other components of the crypto future include contract expiration, units per contract, and leverage.
Crypto optional contracts
These kinds of derivatives provide traders with the choice and prerogative to purchase or dispose of the underlying asset on the designated date or before. It is one of the most popular types of derivatives as it allows the traders to complete the contract. Crypto options also contain three main components which are the following.
Premium: This process involves the buyer paying the seller to enter and fix the contract.
Strike Price The specific price is fixed by the buyer and seller.
Expiry Date: the date on which the final settlement is fixed and carried out.
Crypto perpetual contracts
Perpetual contracts are similar to crypto future contracts but do not involve any expiration date. The traders do not set a specific date and the contract can remain open until the trader decides to close it.
The traders can profit from the long-term opened contract if they pay the funding rate.
Pros and cons of Crypto Derivatives
We must have a profound knowledge of the potential ways to manage trades because such trading derivatives come along with their pros and cons. This part of the article talks about the pros and cons of crypto derivatives that every trader must be aware of.
Pros
- Crypto derivatives are cheaper than spot trading that attracts various kinds of fees.
- It helps the traders to eliminate the possible risk of the shifting prices of the underlying assets.
- Derivatives allow leverage, where the traders can control huge assets with a small amount of capital.
- It helps the traders gain a balanced portfolio and reduce individual market risks.
- Provides a platform for the traders to gain profit from price fluctuations without having to directly own the underlying asset.
- Provides a potential market for hedging activities which in turn contribute to the overall strength of the market.
- It allows traditional investors to participate in the cryptocurrency markets.
Cons
- Due to its unpredictable nature, crypto derivatives often face several risks.
- New traders may find the market challenging as trading derivatives involves precise knowledge about the existing market and instruments.
- Derivatives often involve a disagreement between the two parties thus affecting the contracts.
- Trading derivatives will be affected by the different jurisdictions and their varying rules and regulations.
- Even though leverage offers some profits, traders must use it with profound knowledge. A small fluctuation in prices could lead to extreme losses.
Also, Read: Buy Wall And Sell Wall In Crypto: What Is It? How To Identify them?
The Bottom Line
As a finalizing note, it can be concluded that crypto derivatives are a complex trade that requires much knowledge about the existing market. The system of derivatives has been in use for centuries now.
It enables traders to increase their exposure to changes in the value of an underlying asset without really owning it. As mentioned above, there are various types of crypto derivations, each with pros and cons. It is always important to remember that the nature of cryptocurrency is unpredictable.
Since crypto derivatives obtain or derive their value from underlying assets, they will also have the same volatile nature. To be successful, new traders must possess a thorough understanding of cryptocurrency trading and market trends.
Before investing in derivatives, traders need to read and understand the intricacies of crypto trading and the methods to separate the underlying assets.
