Crypto derivatives represent contracts whose value is determined by an underlying asset. Two parties enter into a contract and speculate on the asset’s price in the future by agreeing to buy or sell the asset on a specific day regardless of the market price. Consequently, investors and traders can profit from changes in the underlying asset price by purchasing the asset at a lower price and selling it higher.
Today crypto derivatives are a trillion-dollar market. For those interested in CFD trading, there are plenty of reputable platforms you can opt for to access these products such as PrimeXBT.
The most common types of derivatives within crypto include futures, options, perpetual contracts, and swaps. A futures contract represents a legal agreement between two parties where they agree to purchase or sell an underlying asset at a specified price and date in the future. A regulated platform will execute the contract directly.
If you have an options contract, you have the choice, but you are not obliged to purchase or sell the underlying asset at a defined future date and price.
Perpetual contracts differ from futures and options since they lack an expiration or settlement date. Under some circumstances, for instance, an account holds a certain amount of crypto, the trader can keep their positions open indefinitely.
As for swaps, they represent a contract between two parties to exchange cash flows at a later date according to a predetermined formula. They are OTC (over-the-counter) contracts similar to forwards and are not traded on exchanges.
Features of derivative trading
There are several features you will find when dealing with derivatives markets. This section will cover the most common. They include auto deleveraging (ADL). Here, when a position cannot be liquidated at a better price than the bankruptcy price, and there is insufficient insurance to cover the contract loss, your trading platform’s ADL system will automatically deleverage an opposing position from a designated trader in case of liquidation.
Another feature is the stop loss and take profit, which allows a trader to specify an order’s floor and ceiling prices. This allows them to exit the market automatically when the conditions are favorable. Also, partial close orders allow one to take partial gains while they continue to benefit from the growing market by partially closing their orders. Additionally, an insurance fund helps a trader preserve their funds from auto deleveraging even if their holdings fall below the maintenance margin level.
Pros of derivative trading
There are plenty of benefits to be found from engaging in crypto derivatives markets, such as access to low transaction costs since derivative contracts are risk management instruments that help reduce market transaction costs. Compared to spot trading, the transaction cost here is relatively cheaper.
Also, you can use derivatives to manage the risk of an underlying asset. For instance, by purchasing a derivative contract whose value swings in the opposite direction of the crypto token you own, you can offset losses from the underlying asset through gains of the derivative.
Derivatives are also characterized by market efficiency due to arbitrage which is vital for the market to find equilibrium, thus ensuring the prices of underlying assets are accurate. For this reason, these contracts are frequently used to determine the price of an underlying asset. And most importantly, it’s possible to transfer risk to other parties using derivative contracts.
Cons of derivatives
Whatever has pros has cons, too, and this isn’t different for crypto derivatives. However, in this case, the pros outweigh the cons. Some disadvantages include high risk due to extreme volatility of the underlying asset price. However, this is why they are also highly profitable if things go your way.
Additionally, these contracts serve as speculative instruments thus can result in significant losses, just like they can lead to high profits.
All in all, crypto derivatives represent one of the easiest ways to succeed within crypto markets. However, you need to invest time to understand how to trade these instruments. It does help to learn how to conduct technical and fundamental analysis and manage risk if you are to make the most of the opportunities they offer. On PrimeXBT you will find plenty of free resources to aid you with this journey.