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Decentralized Crypto Derivatives Explained

As well as in the traditional trading, we’re able to use various financial tools on the crypto market. One of them is called crypto derivatives, which are essentially an agreement between a buyer and a seller for the future value of a digital asset. The participants in this transaction do not own the asset for which the contract was created. In this case, the subject of the transaction is the right to perform the contract.

How do crypto derivatives work?

Derivatives are financial instruments that are based on some asset. The simplest example of it is an agreement to buy Bitcoin on a specific date and at exact price. Crypto derivative is based on the value of the coin at the time of the conclusion of the contract. The asset can be something else, not only cryptocurrencies, but also commodities, currencies, loans, stocks and other securities.

On the exchanges exist spot trading and derivatives trading. In the first case, the traders buy or sell one coin for another. For example, they exchange Bitcoin for USDT. That’s it, spot trading usually involves two coins.

In case of derivatives trading, traders top up their account with Bitcoin or some other cryptocurrency. After entering into agreement a part of these coins will be freezed by the exchange as collateral. To return it, you must fulfill the obligations of the contract. If the transaction is successful, the trader receives back both the deposit and profit. However, if the transaction was unsuccessful, users do not receive the deposit back and there won’t be any profit.

Why use crypto derivatives?

Сrypto trading has its cons. For instance, investors can earn by committing only one action: buy and sell coins when they rise in price.

Derivatives provide an opportunity to earn not only on growth, but also on falling prices. For example, let’s imagine that Bitcoin now costs $30,000, but some traders are sure that the price will soon fall to $20,000. They can use a special type of the derivative called short. It will allow them to take a loan in Bitcoin and immediately sell it, and return it later, when the price drops. So we can borrow 1 BTC and immediately sell it for $30,000. If the price drops to $20,000, we will buy 1 BTC and repay the debt — the profit will be $10,000, which is equal to the difference in BTC price from the sale. By shorting traders might earn on the fall in the price of cryptocurrencies. Also, a profit in ordinary crypto trading is limited by the available amount of assets. The smaller the amount, the smaller the profit.

Derivatives trading can be done with leverage. Traders can take additional funds from some crypto exchanges. For example, x10 leverage increases income by 10 times. However, such trading has the risk of losing collateral, that is, the trader’s balance. With the usual purchase or sale of cryptocurrencies on the exchange, there are no such risks, but it will not work to increase profits several times over. We will tell you more about leverage in one of the following articles.

Types of crypto derivatives

There are 16 types of derivatives in total. In crypto trading these tools are popular: futures contracts, exchange-traded funds (ETFs), swaps and options. Let’s take a closer look at them.

Futures contracts. It is an agreement to sell or buy an asset in the future at a predetermined price. Usually such contracts must be closed before a certain date. For example, a trader agrees to buy 1 BTC for $35,000 by the end of the current quarter. The difference in price is his\her income. It is similar a pre-order of any product, in which the buyer pays a predetermined price, but the goods are received later.

Exchange-traded funds (ETFs). We have a big article dedicated to this financial tool. A Bitcoin ETF is a stock index. The main purpose of a stock index is to create an indicator with which investors could understand the general direction and “speed” of assets’ movement. It monitors BTC by using futures contracts, you can open buy and sell positions with it. If you want to have Bitcoin in your portfolio without actually buying it on crypto exchange, then an ETF is a perfect solution.

Swaps. This tool includes two contracts at once. The first contract is aimed at the purchase or sale of the underlying asset at the time of its conclusion, and the second indicates the conditions for the sale or purchase of the underlying asset in the future. Swaps are considered a more complex version of futures. In simple words, we’re purchasing a product from a supplier and entering into an agreement to supply the same product in the future.

Options. With the help of this contract a trader has the right to buy or sell some crypto asset in the future at a predetermined price. It’s quite similar to asking the seller to hold the goods for a while.

Cryptocurrency exchanges for derivatives trading

Binance Futures. It is arguably the key arm of the Binance exchange with over $50 billion in daily trading volume. The platform provides the opportunity to trade USDT-M and COIN-M derivatives, with leverage up to 20x, choosing cross or isolated margin. High order processing speed and excellent liquidity make this exchange a truly optimal choice for trading cryptocurrency futures.

Bybit. It is a cryptocurrency derivatives exchange that offers a convenient and secure exchange interface for both traditional and digital currencies. Among the derivative instruments there are perpetual contracts that do not require immediate settlement. They allow clients to hold positions for a long time This crypto Exchange supports perpetual contracts and futures with week/quarter expiration, as well as options and CBCC (Bear/Bullish Redeemable Contracts). You can activate the copy trading function to achieve better performance and automation.

Bitmex. Professional traders and investors often choose to trade Bitcoin derivatives through the Bitmex platform. The platform offers high leverage and strong security protocols. It supports futures that can be done in either cash or crypto. The contracts do not require traders to place 100% collateral as a margin, so it is possible to use leverage up to x100 on some contracts.

How to use crypto derivatives

Derivatives are financial instruments based on any asset: cryptocurrency, commodity, securities, etc. They give the trader 2 main benefits:

  • Earnings not only on an increase in the price of an asset, but also on its fall.
  • Trading with leverage provides an opportunity to increase income, but also increases risks.

Traders earn money depending on price fluctuations of the cryptocurrency they are interested in. All bidders take some risk because no one can know exactly what the value of a currency will be in the future. If the asset has become more expensive, then the buyer wins, if it becomes cheaper, then the seller earns.

To increase the level of their earnings, a trader can use leverage (lever). The leverage multiplies the possible profit many times over. The amount of available leverage depends on the chosen trading platform. Also, you will have to pay a commission for credit funds. Don’t forget about risks, be careful with your decisions.

The easiest way to buy or exchange coins is to use SimpleSwap services. SimpleSwap reminds you that this article is provided for informational purposes only and does not provide investment advice. All purchases and cryptocurrency investments are your own responsibility.

Originally published on our Publish0x blog.



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