What Are Cryptocurrency Derivatives and How to Use Them?

What Are Crypto Derivatives, and Are They Regulated?

Derivatives, in simple words, are futures contracts that specify the predicted price of an asset. There are derivatives on stocks, commodities, securities, and cryptocurrency. Basically, transactions are concluded under settlement contracts, which, unlike delivery contracts, do not imply the actual purchase/sale of the underlying asset.

In Europe, the derivatives market is regulated by the European Market Infrastructure Regulation (EMIR). In the USA, derivatives trading is controlled by the Commodity Futures Trading Commission (CFTC). The Securities and Exchange Commission (SEC) also regulates some derivatives but is mainly responsible for the securities market.

Popular Cryptocurrency Derivatives

Let’s look at the most common cryptocurrency derivatives:

Futures

This is a contract for selling and buying cryptocurrency at a certain rate in the future. Investors can make money on the difference between the contract price and the market price of the asset at the time the contract is executed. Each transaction includes two positions: a long position (to buy) and a short position (to sell).

When a person opens a long position, it means they agree to buy the cryptocurrency at the price specified in the contract. If the market rate is higher by the time it is executed, the long position will be profitable because it allows buying the crypto cheaper.

On the other hand, if the market value of the coin at the time of execution is lower than the one specified in the contract, the long position will be unprofitable, and the buyer will have to purchase the asset at a higher price.

A short position works in the opposite direction: if the market value is higher than the one specified in the agreement, the short position will be unprofitable, and if it is lower, it will be profitable.

However, more often than not, investors do not reach the stage of executing contracts and close them before the deadlines, making profits or losses on the price difference without buying coins.

Options

It is a derivative that gives the trader the right (not the obligation) to buy or sell crypto at a predetermined value during a specified period:

• Call options. If the market rate rises above the set strike price, the buyer can exercise the option and make a profit.
• Put options. If the asset’s market value falls below the set strike price, the buyer can exercise the option and make a profit on the difference in rates.

If the contract price turns out to be unfavorable, the trader may not exercise the option. The loss will be limited to the margin (collateral) paid at the time of purchase.

CFD

These are contracts for price differences that allow speculating on the fluctuations of an asset without owning it. Investors enter into a contract in which they agree to the difference in the value of the cryptocurrency between the opening and closing of the transaction and then make a profit or suffer a loss. It is possible to record the financial result at any time.

One of the features of CFDs is the use of leverage, which gives the right to open positions with higher values than their initial deposit (margin).

What is the mechanism of trading derivatives for cryptocurrency?

To trade derivatives, you need to follow the steps below:

1. Open an account at an exchange or broker.
2. Replenish the account.
3. Select a derivative, taking into account its type, currency, and expiration date.
4. Place an order and monitor its execution.

To buy cryptocurrency derivatives, you need to pay a commission to the exchange or broker, as well as deposit margin collateral (a percentage of the value of the coin).

Suppose you want to buy Bitcoin futures totaling $40,000 for up to 3 months, hoping the coin will rise in value. If the price rises to $45,000, you can sell the futures and make a $5,000 profit. If the price drops to $35,000, you will make a loss of $5,000.

Benefits of Cryptocurrency Derivatives

Having found out what cryptocurrency derivatives are, let’s talk about their benefits:

• The opportunity to earn both on the rise and fall of prices;
• No need to buy crypto;
• A wide range of tools and the ability to quickly enter and exit trades;
• Leverage that allows you to increase your positions.

Trading derivatives in crypto is a complex process that requires investors to carefully study the specifics of this tool, analyze the market, and understand the risks.