Cryptocurrencies continue to transform the economic system as they gain momentum as fair-value financial intermediaries in monetary operations. Crypto derivative is an example of an industry that has seen rapid growth and expansion. As the crypto market grows, so does the variety of cryptocurrency products available. This article covers the basics of crypto derivatives products, such as crypto perpetual swaps and crypto futures contracts, and the benefits of each.
Cryptocurrency derivatives are a vital part of the market, offering traders and investors a variety of ways to trade and invest in digital currencies. Two of the most popular types of derivatives are crypto futures contracts and perpetual swaps. But before dwelling on the types of derivatives, let us understand what crypto derivatives mean.
What Are Crypto Derivatives?
Any product or contract whose value is measured by an underlying asset is considered a derivative. Derivatives extract their value from investments such as stocks, securities, interest rates, commodities, stablecoins and cryptocurrencies in conventional markets. Like classic derivatives, a buyer and seller enter into a pact or agreement to sell an underlying security.
These securities are exchanged at a specified time and price. As a result, derivatives lack intrinsic value and are dependent on the underlying security. An Ethereum derivative, for example, depends and derives its value from the value of Ethereum. Crypto futures contracts and crypto perpetual swaps are the most common types of crypto derivatives.
What Are Crypto Futures Contracts
A futures contract involves an exchange between two parties (buyer and seller) to trade a crypto asset at a predetermined price. In other words, futures contracts allow potential parties to reach an agreement on the value at which the asset exchange will take place in the future. While crypto futures swap durations vary, settlement dates are always set to avoid last-minute confusion. Be mindful that:
Before two parties agree on the crypto futures contract, they should have a consensus on a predetermined closing date.
- Cryptocurrency futures allow traders to buy or sell a certain amount of a cryptocurrency at a set price.
- These contracts are standardised, meaning that each contract has the exact specifications.
How Do Crypto Futures Contracts Work?
Let's say bitcoin is trading around $30,000 and Ellie, a crypto derivatives trader, believes the price will see more bullish momentum in a few months. She can bet on that probability by agreeing to a contract that allows her to buy 1 BTC for $30,000 every month.
All she has to do is open bitcoin futures contracts, which together represent her commitment to pay $30,000 for 1 BTC next month, regardless of the spot market price. On the other side of this trade, Joe believes that bitcoin's price will fall below $30,000 by the proposed settlement date. He has agreed to sell Ellie $30,000 in contracts next month. Ellie is "longing" bitcoin, whilst Joe is "shorting" the digital currency.
Ellie would have made a $10,000 profit if the price of bitcoin rose to $40,000 by the contract's expiration date since she would have purchased BTC at a discount from Joe. If the price of BTC fell below $30,000 on the settlement date, Ellie would be forced to purchase bitcoin from Joe at a higher price than the current market, suffering a loss.
The crypto futures contract remains one of veteran traders' most sought-after investment strategies. There are high risks in futures contracts; therefore, its perks are significant. A trader can make excellent gains if proper techniques and strategies supplement the trade.
Highlights of Crypto Futures Contracts
The features that crypto futures contracts offer traders are summarised below.
Unlike Perpetual Swap, futures traders do not pay the funding cost twice throughout a trading day (if the market is in a favourable trend; otherwise, vice versa) and can thus potentially minimise payer fees.
Increased market depth
Futures are among the largest and most sought-after crypto derivatives with millions of users. The significant trading activity and liquidity may favour traders.
Increased cryptocurrency trading options
The futures market allows traders to trade all major digital currencies, including BTC, ETH, and LTC, to name a few.
Now that you understand the futures contracts let's look at the perpetual crypto swap, the other prominent derivative in the crypto industry.
What are Crypto Perpetual Swaps?
Crypto perpetual swaps can be understood as a class of derivatives contract that allows traders to predict/speculate on the future price movements of cryptocurrencies. They are similar to traditional futures contracts but do not have an expiry date. Crypto perpetual swaps offer several benefits over traditional futures contracts.
- Firstly, they offer much more liquidity so that traders can trade them anytime.
- Secondly, there is no need to physically deliver the underlying assets, which reduces the risk of settlement failure.
- Finally, they provide traders with a way to hedge their cryptocurrency investments against price volatility.
What Is The Best Way To Trade a Crypto Perpetual Swap?
When many traders decide to go long, and the price of the perpetual contracts steadily rises above the spot price, there is no reason for people to enter short positions. This situation leads to a positive trend, and thus the funding rate is also positive.
When the funding rate in perpetual crypto swaps is positive, all long position holders must pay for short positions. On the other hand, a negative funding rate means that all short position holders must cover long positions.
The funding rate is used by crypto derivatives such as perpetual swaps or futures contracts to ensure the consensus of value at regular intervals. The ultimate goal of the funding rate is to maintain the price of an asset contract in line with the spot value of the underlying asset and prevent massive price deviations.
It is essential to realise that the funding rate is a payment made by the two contracting parties (long and short parties), and no price is sourced from the exchange. The agreement encourages traders to exit long positions and enter short positions to bring the asset's price (e.g. Bitcoin) back to its original value. Transactions are processed, and payments are made directly to traders rather than through exchanges.
Highlights of Crypto Perpetual Swaps
Now that we have discussed the perpetual swaps, we can summarise the features associated with them as follows:
Since the contract has no expiry date and no delivery, it saves traders a lot of time as they have to roll over their contracts regularly.
Increased fund flexibility:
Profits and losses are generated and reversed twice a day. This allows traders to exit trades and move funds to other accounts for use.
Up to 150x leverage allows you to earn a greatly amplified profit. However, you should beware of the more significant consequences.
Futures Or Perpetual Swaps: Which One Is Best Suited For You
The crypto market is growing exponentially, and new products and services are constantly being developed to cater to the needs of traders. Perpetual contracts, unlike futures contracts, are traded based on the underlying index price and therefore trade at prices very close to spot markets.
Crypto perpetual contracts are better suited for traders who enjoy trading on the typical spot exchange. Perpetual contracts allow traders to borrow up to 150x leverage to enhance earnings. It implies that buyers can open trades worth 150 Bitcoin with a deposit of one Bitcoin. The low investment threshold appeals to individual traders who can benefit from the booming cryptocurrency industry.
Since the contract does not expire, traders do not have to make the trade every time. As a result, perpetual contracts are desirable over futures for many traders and the broader blockchain ecosystem. They are a testament to the evolution of the crypto markets.
As crypto futures and perpetual trading become more streamlined, crypto exchanges face over-the-top pressure to meet the surging demand. It becomes vital that traders use a robust and trustworthy exchange. It should cater to both professional and retail traders equally. Also, it has to be capable of handling high volatility and market depth without causing any delay.
Things To Keep In Mind When Using Crypto Derivatives
Now that we have crypto perpetual swaps and futures contracts explained, it becomes imperative to choose one. As a newbie trader, you are often advised to stay away from risks as long as you don't have a good hold of the crypto market terminology. Well, that advice forms the fundamentals of crypto trading. Along with that, there are some other rules that you should remember as a trader.
Risk only the investment that you can afford to lose. If you go up and beyond measures to get rich, you will have a quick fall. Investment risk management is an essential feature of crypto trading.
- Trade according to market sentiment. If you identify a trade and market movement does not favour it, wait for the correction and only then place a trade. If you do the opposite and make an open order, it will severely impact your portfolio.
- When leverage trading, make sure you choose an exchange that has an easy-to-use interface and offers good leverage options.
- Furthermore, exchanges should be fair in dealing with all traders and give them equal opportunities to take positions without being subject to system failures.
There is no single formula that guarantees profits when trading crypto derivatives. However, there are specific techniques you can employ to protect your investment further and sustain the overall growth of your portfolio. Before deciding on Crypto Perpetual Swaps or Futures Contracts, you must be fully aware of the decision and fully committed to it. Choosing the suitable derivatives involves choosing the most sought-after derivatives strategy.
For example, you may need an options contract if the market is bullish. However, if the market trend is bearish, a crypto futures contract is a better alternative. If you are indecisive due to unpredictable market movements, you can go with a perpetual futures contract to be on the safe side regardless of market movement.
A regular crypto futures contract may not necessitate the payment of capital rates. You only pay the interest amount, which is calculated annually. If your speculation fails, there always remains a strong possibility of risk and overall investment loss.
There is no way to avoid a potential loss when using crypto derivatives because both parties need to agree on the contract and settle it. In contrast, Options trading facilitates a break from the obligated settlement because traders can choose to deviate from the contractual terms. In this situation, the only loss that traders can sustain is the premium amount they have to give other parties (seller).
Funding rates are an integral part of the perpetual contracts that you must pay or receive based on the price variation of the asset. Crypto Perpetual Swaps' main advantage is that it does not have an expiry date. As a result, you can trade and profit from crypto-asset price volatility indefinitely. As a result, you can bet on and profit from crypto-asset price volatility indefinitely if you maintain a positive balance in your account.
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