Guide to Crypto Derivatives: What is Cryptocurrency Derivatives?

Derivatives trading allows traders to hedge the underlying crypto assets and mitigate risks through future predictions and betting of crypto market prices. Bitcoin options are also crypto derivative contracts that follow the price of bitcoin, except these do not necessarily have to be settled at their expiration dates. The reason these are called options is that they give traders the option or right to buy or sell at predetermined prices at specified future dates. Traders often utilize derivatives to speculate on the prices of cryptocurrencies, with the main objective of profiting from the changes in the price of the underlying cryptocurrency. For instance, a trader might attempt to profit from an anticipated drop in the general prices of cryptocurrencies by ‘shorting’ the coin. Shorting – or short-selling – refers to the act of betting against the price of a security.

  • In this article, Ledger takes a deep dive into the world of crypto derivatives, exploring what they are, how they work, and what you should know before getting involved.
  • Trading volumes are estimated at between 10 – 20 times more than the market for spot trading, so we are seeing more and more trading platforms spring up to fulfill the demand.
  • When the contract expires (i.e., on the set future date), the buyer is obligated to purchase and receive the asset, and the seller is obligated to sell and deliver the asset.
  • You can re-enter the market once prices have fallen and buy back the same amount of securities that you initially sold.
  • Traders can diversify their portfolio with ETFs without actually having to buy and own the assets tracked by said ETF.

However, this can only be done in a bull market, or when the market is trending upwards. Shorting is a way to profit from a bear market, or when the market is in a downtrend. By entering into this agreement, you reduce your risk of having to pay a higher monthly price throughout the year.

Comparison Between Derivatives and Spot Markets

To explain, this tool will automatically sell a position if it reaches a certain price, limiting potential losses. Additionally, traders often diversify their portfolios across different assets to avoid overexposure to any one position or asset. For example, if the price of the perpetual contract exceeds the index price, traders who have taken a “long” position typically pay the funding rate to compensate for the price difference. Conversely, if the perpetual futures contract price is lower than the index price, traders with a “short” position pay the funding rate. Crypto futures are a type of derivative contract that allows two parties to agree on the price of a cryptocurrency at a fixed date in the future.

To trade exchanges, traders make use of exchanges or customer-to-customer (C2C) platforms. Though the term of use of the two methods differs, active traders still consider them important. However, the contract will expire after the settlement date so both parties have to keep track of the contract. Derivatives trading increases price stability and cushions the traders against sudden price shocks. Derivatives can allow other cryptocurrencies to enter the market and contribute to the liquidity and bring equilibrium in the market. The participation of more players in the market also shifts or distributes the risk to others.

crypto derivatives meaning

Chicago Mercantile Exchange (CME) is currently the biggest derivatives exchange in the world, managing over 20% of the total derivatives trading volume on a global scale. LedgerX was the first regulated institutional exchange that introduced Bitcoin derivatives, in the form of swaps and options. Only accredited investors and institutional players can trade on LedgerX’s trading platform. Below are some questions to answer in determining if crypto derivatives trading is a good option for you.

Differences Between Derivatives and Spot Market

Upon expiration of the contract, the buyer is obligated to receive and purchase the asset, while the seller is obligated to deliver and sell the asset. Crypto derivatives operate similarly to traditional derivatives, where a buyer and seller enter into a contract to sell an underlying asset, with the asset being sold at a predetermined time and price. With the rise of cryptocurrencies, derivatives have emerged as a popular tool for traders to manage risk and speculate on the price movements of digital assets. On the day of the trade, both the crypto traders have to honor the price (both buying and selling) that was decided on the day the contract was signed. Crypto derivatives trading can be done on DeFi (Decentralized Finance), CeFi (central finance), and C2C (customer-to-customer) markets.

This guide to crypto derivatives takes an introductory look into an interesting development, tackling a core question on what is cryptocurrency derivatives. Trading in the derivatives market is a lot more complex than in the spot market. At any time before the expiry date, the crypto option holder can decide whether or not to exercise their option.

For example, a trader may only need to put down 10% of the total value of a futures contract. For instance, on the crypto exchange Binance, a trader can leverage up to 125 times the initial margin. But while leverage can amplify potential profits, it also drastically increases the risk of losses.

crypto derivatives meaning

Traders who wish to profit from price movements in the cryptocurrency market without worrying about expiration dates sometimes employ perpetual contracts. In today’s modern financial and crypto markets, where futures can be used to gain exposure to price movements of an underlying asset, actual physical delivery of the asset does not have to occur. Instead, the profit or loss resulting from the trade would be posted to the trader’s account (this is sometimes referred to as cash settlement).

The option contracts automatically terminate (get ‘knocked out’ and cease to exist) if the underlying asset’s price touches any predetermined levels. This is not to be confused with the strike price, the price at which the option holder buys or sells the asset if they exercise their right to do so. The Knock-out feature potentially limits profits and losses for both option holders and option sellers. Futures are a type of derivative contract agreement between a buyer and a seller to buy and/or sell a specific underlying asset (such as a cryptocurrency) at a set future date for a set price. When the contract expires (i.e., on the set future date), the buyer is obligated to purchase and receive the asset, and the seller is obligated to sell and deliver the asset. Crypto exchange OKX also offers futures as well as USDT-margined and coin-margined perpetual swaps trading, which is a contract that has no expiration date with up to 125x leverage.

Derivatives on the Exchange

Derivatives also predict the price variation and future risks of a crypto asset. One of the hardest challenges of crypto trading is the volatility of the market. Derivatives allow crypto traders to hedge against investment risks that help to downsize the risks of the market.

These are derivative contracts between parties with a pre-determined market price and trading date irrespective of the price of the crypto asset on that particular settlement date. Crypto derivatives are trading tools that reduce the cost of overall transactions. The cost of spot trading in crypto market exchanges is much higher compared to crypto derivatives. Crypto derivatives tend to attract professional and institutional traders who contribute to the liquidity of the crypto market. Increased liquidity means there are more buyers and sellers in the market and more transactions can take place.


From AMM to yield farming, learn the key vocabulary you’ll encounter when trading on a DEX.

crypto derivatives meaning

Derivatives are contracts whose values depend on the value of other underlying assets. In the derivatives market, traders leverage their holdings, speculate on the price direction of underlying crypto assets, and hedge positions. Derivatives allow traders to get exposure to the price movement of an underlying asset without actually owning it. With the advent of cryptocurrencies, they have also become an important part of the crypto market for market participants, mainly used for hedging and speculation purposes.

Accordingly, traders must check the laws and regulations of their country before engaging in derivatives trading. A lack of liquidity can result in wider bid-ask spreads, increased volatility, and higher transaction costs, making it difficult for traders to enter and exit positions at desirable prices. It can also deter institutions, which typically require a certain level of liquidity to put in large sums of money.

What are the most popular types of derivatives in crypto?

A major factor affecting this decision is usually where the market price is in relation to the strike price — this determines whether a profit or loss is made from exercising the option. Both can be entered into as a long position (i.e., buying the option) or a short position (i.e., crypto derivatives meaning selling the option). Crypto derivatives cannot be traded just anywhere; there are dedicated platforms for it. When the price eventually falls, the trader buys the same amount of assets again, but this time at a lower price, and as the price fluctuates, they make profits.

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