Table of Contents
- Understanding Crypto Derivatives?
- Different Types of Crypto Derivatives
- Bottom Line
- Frequently Asked Questions (FAQs)
Show moreShow less
Understanding Crypto Derivatives?
Crypto derivatives are financial instruments that derive their value from underlying crypto assets. Traders place their bet based on speculation of the price movements of crypto tokens, and can choose to either sell or buy the asset. The transaction can either happen through physical delivery of crypto tokens, or directly through cash settlement into the trader’s account without owning the asset.
Being a high-risk financial instrument, advanced traders can heavily maximize gains from crypto derivatives. However, the crypto market is extremely volatile and derivatives can have the opposite effect due to fluctuation on price movements—making their investment portfolios much riskier.
Featured Partners
1
Mudrex
Legacy
Over 2 Million Investors Trust Mudrex for Their Crypto Investments
Security
Mudrex is Indian Govt. recognized platform with 100% insured deposits stored in encrypted wallets
Fees
Enjoy zero crypto deposit fees and industry's best fee rates.
On Mudrex's secure application
Multiple Award-Winning Broker
Listed On Deloitte Fast 50 index, 2022 Best Global FX Broker - ForexExpo Dubai October 2022 & more
Best-In-Class for Offering of Investments
Trade 26,000+ assets with no minimum deposit
Customer Support
24/7 dedicated support & easy to sign up
On BlackBull Market's secure website
Please invest carefully, your capital is at risk
Different Types of Crypto Derivatives
Crypto derivatives are complex financial contracts that take place between a buyer and seller, and often corroborates with high-risk, high returns strategies. Crypto exchanges facilitate traders to invest in derivatives that come with three variations: crypto futures contracts, perpetual contracts, and options.
Crypto Futures Contracts
Crypto exchanges facilitate crypto futures contracts between two parties agreeing on the predetermined price for buying and selling crypto tokens, such as Bitcoin or Litecoin, and comes with an expiration date for the contract to end. At the time of contract expiration, if the market price of the said cryptocurrency goes above the set price, the buyer makes a profit. Sellers will profit if the market price falls below the predetermined price.
To cite an example, say X agrees to buy Litecoin from Y via crypto futures contract on WazirX at a set price of INR 7,045.72 on the last Friday of the month at 8:00 UTC. If the market price of the cryptocurrency goes up by 20%, X can either choose to buy Litecoin from Y at the predetermined price of INR 7,045.72 instead of the increased price, or get the increased amount credited into the account. Similarly, Y will profit by the percentage of the decreased value of the set price against the market price of the crypto.
The process of buying crypto tokens on crypto exchanges through crypto futures contracts is known as long position, and short position for selling. The transaction can either happen through physical delivery of crypto tokens, or directly through cash settlement into the trader’s account without owning the asset.
Components of crypto futures contracts
- Contract expiration: Crypto futures contracts have a predetermined expiration date (usually eight hours on most crypto exchanges) which the buyer and seller are obligated to settle at the pre-agreed price of the crypto token. It is one of the key differentiators from crypto perpetual contracts, which is another type of derivatives.
- Units per contract: It is an important component of crypto futures contract that represents the amount and value of each (usually in USD depending on the exchange) crypto futures contract and varies among crypto exchanges.
- Leverage: Crypto exchanges allow traders to maximize returns on crypto futures bet. Remember, leverage substantially increases the risk of losing money, and the investment technique is recommended to be used only with caution.
Crypto Perpetual Contracts
Similar to futures contracts, crypto exchanges facilitate traders to bet their investment on perpetual contracts. The key differentiator, however, between the two financial instruments or derivatives is that the component of “contract expiration” is taken out from perpetual contracts. This means, there’s no expiration date and traders can choose to speculate the market price of the underlying crypto and hold their position (long or short) for an indefinite period — provided they agree to pay the funding rate (the spot price of the crypto), which is usually after eight hours in most crypto exchanges. Profitable traders can choose to either withdraw their earnings, or continue to hold their positions.
Crypto Options
Another type of derivatives that has gathered popularity in the world of crypto trading is options. Such a type of financial instrument gives traders the option to fulfill the contract, but doesn’t bind them to buy or sell the underlying crypto at a predetermined price on or before the expiration date. Crypto options has three main components, as follows:
- Premium: The price buyer pays the seller to enter a crypto options contract.
- Strike price: The fixed price at which buyer and seller agree to enter the contract.
- Expiry date: The date at which the final settlement is carried out.
Crypto options have two variants. Call option allows traders to buy crypto tokens at a price lower than the current rate. Put option, on the other hand, allows traders to sell it above the market price. Remember, in both options, traders are free to exercise their right to fulfill the contract without obligation to buy or sell the underlying crypto.
Pros and Cons of Crypto Derivatives
| Crypto Futures Contracts | Crypto Perpetual Contracts | Crypto Options |
|---|---|---|
| Risk: Poor trading strategies, and taking unnecessary leverage may pose high risk. | Risk: Crypto’s volatile nature can either lead to profit or loss due to price fluctuation. | Risk: Limited. However, traders may face losses if they fail to correctly predict market movements. |
| Hedging: Can be used to hedge against market volatility and diversify crypto portfolio. | Hedging: Perpetual contracts offer crypto traders hedging opportunities against price volatility. | Hedging: Crypto options can be a useful hedging tool to mitigate risk if the strategy is correctly implemented. |
| Leverage: Traders can maximize gains but amplify risk, and are recommended to tread with caution. | Leverage: Similar to futures, perpetual contracts allow traders to profit through leverage. | Leverage: Correct prediction of the price movement is key to make maximum gains through leverage. Similarly, loss can be drastic. |
| Flexibility: Even non-crypto holders can predict asset’s price movements and earn profits. | Flexibility: Traders can indefinitely speculate the price movement of crypto tokens, but carries equal risk. | Flexibility: Traders can choose strike prices and expiration dates of crypto tokens, and predict its future movement, either bullish or bearish. |
How To Start Investing on Crypto Derivatives
Before investing in crypto derivatives, it is important to become familiar with the process of cryptocurrency trading, obtain appropriate financial advice and only invest what you can afford to lose.
The process to start investing in crypto derivatives includes choosing the crypto exchange, and following the self-explanatory registration process. Here’s a step by step process to start investing on crypto derivatives:
- Step one: The first step to trading on crypto derivatives is to open an account with a crypto exchange using your email address, and setting up a password. This process will be followed by verifying the OTP sent to your registered email.
- Step two: In India, it is mandatory to submit KYC details, including your PAN card and Aadhaar Card details before you start investing in cryptos. Some exchanges require OTP verification for Aadhaar.
- Step three: Once the verification is processed, you are all set to start the trading. The next step is to add funds to your account by linking your bank account, authorizing wire transfer, or making a payment using your credit or debit card.
- Step four: Create wallet setups through crypto wallet, which is a software program used to manage cryptocurrency where you can send, receive, and store Bitcoin, Litecoin, Dogecoin, and other cryptocurrencies,
- Step five: Place your crypto derivatives order by selecting the crypto pair, such as BTC/USDT, DOGE/USDT, and selecting your position whether to buy or sell.
Related: How To Buy Cryptocurrency
Bottom Line
Crypto derivatives involve speculating price movement of underlying cryptocurrency on the market, often corroborates with high-risk, high-return strategies. For less advanced traders, derivatives require extensive research and in-depth knowledge of crypto trading and market movements, and usually involve a large amount of capital. Cryptocurrency can be extremely volatile, and you should tread with caution before you invest in derivatives.
Frequently Asked Questions (FAQs)
What is the difference between futures and perpetual contracts?
The key differentiator between crypto futures and perpetual contracts is that the latter type of derivatives has no expiration date, and traders can choose to speculate the market price of the underlying crypto and hold their position (long or short) for an indefinite period.
What is the difference between crypto futures and crypto options?
Crypto futures binds both buyer and seller to fulfill the terms of the contract, while options provides traders with the option to fulfill the contract, but doesn’t bind them to buy or sell the underlying crypto at a predetermined price on or before the expiration date.
What is the difference between crypto arbitrage and crypto derivatives?
Crypto derivatives is a high-risk financial instrument that involves speculating price movement of the underlying cryptocurrency on the market, while crypto arbitrage is a strategy that involves identifying price differences across exchanges to make gains from the risk-free strategy.
