What are crypto derivatives

Crypto for Advanced
> 3 min. read
What are crypto derivatives

Secondary contracts or financial tools that derive their value from a primary underlying asset are known as crypto derivatives. The major asset in this situation would be a cryptocurrency like Bitcoin.

Crypto futures, crypto options, and perpetual contracts are the most popular crypto derivatives.

A Bitcoin spot market allows traders to buy and sell Bitcoins at any moment, but there are some restrictions. For instance, investors can only profit if the price of Bitcoin rises. Anyone holding BTC will lose money if the price falls. Even those who were fortunate enough to sell before a substantial drop and want to repurchase at a lesser price need prices to rise again. If they don't, there is no way to make money. Another feature of spot markets is that they compel traders to keep the assets they want to speculate on in their possession.

A Bitcoin derivative, on the other hand, allows traders to trade contracts that track the price of Bitcoin without ever having to hold any of the cryptocurrency. These are agreements that you get into with a third party. Let's go back to BTC and pretend that you believe the price will rise while someone else feels it will fall. You and this other speculator can agree that after a given amount of time, once the price has changed in any way, one of you will have to pay the other the price difference.

Crypto futures

A Bitcoin future is essentially a contract or agreement between two parties to buy and sell BTC at a set price on a set date in the future (hence the name). Neither side, in this situation, is needed to hold the underlying asset, which is Bitcoin. Instead, they just settle the deal in US dollars or any other currency that has been agreed upon. The precise settlement date distinguishes futures contracts from other crypto derivative instruments.

Crypto options

Crypto options are similar to crypto futures in that they track the price of cryptocurrencies but do not have to be resolved at their expiration dates. The name "options" comes from the fact that they provide traders the option or right to buy or sell at predetermined prices on specific dates in the future.

Perpetual contracts

Crypto perpetual contracts are crypto derivatives with no expiration or settlement date, unlike futures or options. Under certain conditions, traders can leave their positions open for as long as they desire. One of them is that the account must have a certain number of cryptocurrencies in it (margin). Another important consideration is the funding rate. This is a one-of-a-kind method that helps bind the perpetual contract's price to the price of a coin. A futures contract's price will always converge with the price of the underlying asset at expiration due to its time limit. Because perpetual contracts do not expire, their prices may begin to diverge dramatically from those of bitcoin. One solution to this is to have one side of traders pay the opposing side.

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