You've probably heard about the burgeoning cryptocurrency derivatives industry, with every significant crypto exchange striving to offer the most up-to-date derivatives product. Due to its nascence, you might not know what crypto derivatives are or how they are used in the market. You may be wondering why derivatives are so crucial in crypto-economics. What does this have to do with cryptocurrencies and thousands of similar questions?
This article describes what cryptocurrency derivatives are and how traders and investors use derivatives to increase investment returns. Also, how they employ derivatives as a strategy to reduce risk to their investment. Finally, you will discover why derivatives are so crucial for the crypto-economy.
What Are Derivatives?
The crypto economy is the next frontier in financial services. It's a constellation of constantly evolving and expanding technologies, businesses, and communities. Its innovative nature makes it a breeding ground for cutting-edge financial products. Derivatives are among the most exciting of these products. They are instruments that derive their value from an underlying asset, such as a security or commodity.
Cryptocurrency Derivatives have become an essential tool for managing risk and facilitating the flow of assets and capital. Futures, options, and swaps are collectively referred to as derivatives. They allow investors to protect against risk or speculate on the direction of market prices. Derivatives also provide liquidity to markets and enhance transparency. They also provide leverage, which magnifies returns for investors.
Types of Crypto-Derivatives
Crypto futures, options and perpetual swaps are the derivatives that crypto exchanges commonly offer. Let’s take a brief look at each of them:
Crypto futures and perpetual swaps, like regular futures contracts, derive their value from an underlying crypto asset. Crypto futures contracts have a finite lifespan and expire according to the calendar cycle in which they were issued. For example, a quarterly BTC futures contract expires three months after being issued.
Bitcoin and Ethereum are the two most traded cryptocurrencies in options derivatives. The options market is modest compared to the overall crypto futures market due to the limited range of available assets. Experienced traders often employ Options with complex strategies to buy or sell multiple option positions. Options offer protection against losses and leveraged profits, but they can also have disadvantages, such as the obligation to pay a premium in advance.
Perpetual contracts, on the other hand, have no expiry date. Unlike typical futures contracts, traders don't have to keep track of different delivery months. A trader can hold a position indefinitely unless liquidated in that situation.
In perpetual contracts, positions can be held for as long as the trader wishes, provided they pay holding fees known as the funding rate. The account must also contain a minimum amount known as margin. The underlying assets tend to change in price, which means that the difference between the index price and the price of perpetual futures contracts is typically huge.
For example, if the price of the perpetual contract is higher than the index, those who decide to go long will typically pay the funding rate to make up the price difference.
Why Derivatives Are Essential in the Crypto Economy
Cryptocurrency derivatives are critical to the crypto economy since their functions extend well beyond a single trader's trading portfolio. Derivatives are a crucial part of any well-developed financial system, and they aid in recognizing cryptocurrencies as an asset class. Moreover, Cryptocurrency derivatives increase liquidity, mitigate risks, facilitate portfolio diversification and optimize price discovery.
Derivatives play an essential role in the crypto economy. They increase liquidity and provide a way for investors to manage their risk. Cryptocurrency derivatives increase liquidity in the crypto economy by providing market makers with the ability to manage their risks and earn a profit. It also allows market makers to provide their services to a broader range of customers and increases the amount of liquidity in the markets.
Due to the significant volatility of crypto-asset prices, derivatives can shield a portfolio from unforeseen risk. Because it mitigates the risk posed to an investment, a strong derivatives market helps attract professional traders and institutional investors to the crypto business. Derivatives can also help predict risk, especially in volatile markets where option values are frequently overbought.
Facilitate Portfolio Diversification
Traders can diversify their investment portfolios more easily with derivatives. You can diversify your portfolio with numerous crypto assets and learn advanced trading tactics. Examples are arbitrage, pair trading, short selling, and advanced trading tactics. As a result, more sophisticated trading techniques improve the underlying crypto asset's market liquidity.
Optimize Price Discovery
The primary function of a marketplace is price discovery, which constantly determines the current price of a specific asset. Prices are influenced by various factors, including liquidity, market structure, and information flow.
Crypto derivatives allow investors to optimize price discovery by allowing them to go long or short. As a result, this improves the efficiency of price discovery mechanisms by allowing for smoother market adjustments. Price reliability improves due to improved price discovery, resulting in a more efficient market. Investors are also confident that all relevant information has been considered and factored into the asset's price.
How To Trade Cryptocurrency Derivatives Efficiently
There is no one-size-fits-all approach for avoiding losses while executing crypto derivatives trading. You may, however, follow some guidelines to protect your money as much as possible and guarantee that you are making a rational decision before investing.
Choosing the proper derivative based on the current price fluctuation trend is the key to determining which derivative is suitable for you. For example, if the market is bullish, you should use an options contract. If the market is bearish, buying a futures contract is better. If you're unsure or the market is acting unpredictably, you might opt for a perpetual futures contract to be protected regardless of the market's movement.
Choosing The Right Cryptocurrency Derivatives Trading Platform
Another critical factor to consider is choosing a trustworthy crypto derivatives trading platform. Choose one that is well-established, has verified users, substantial trading volumes, and fraud-detection safeguards.
C-Trade is one of the best cryptocurrency derivatives exchanges because of its incredible bonuses, rewards, and competitions that encourage derivatives traders. It also supports lightning-fast transactions, so you don't miss out on a good trading opportunity. You can trade derivatives linked to Bitcoin, Ethereum, Litecoin, Ripple, Binance Coin, and Bitcoin Cash.
Three significant features of the C-Trade cryptocurrency derivatives exchange are:
1. Up to 150x leverage on Bitcoin perpetual contracts.
2. C-Trade derivatives exchange processes up to 10 million transactions per second.
3. The derivatives exchange employs machine learning to monitor market manipulation.
The impact of cryptocurrency derivatives trading on the crypto market is very binary. On the one hand, it provides traders with hedging tools that mitigate market volatility risk. In the long run, this feature increases the underlying asset's volatility. On the other hand, high leverage increases the risk of forced liquidations and increases underlying fluctuations in the short term.
The bridging function of specially regulated cryptocurrency derivatives, allowing institutional players to access the crypto market, is one of their most significant advantages. The institutional adoption of cryptocurrencies will bring additional capital in the long run, improving liquidity and lowering volatility. Analyzing the crypto markets through derivatives trading requires a detailed examination of several indicators that work in synchrony.
Investors should keep an eye on the current leverage level as its uptrend will likely signal an imminent market decline in the short term. Open interest enters the market as long or short positions. An overly leveraged market has historically been an enemy of cryptos, exemplifying Warren Buffett's rule," Be fearful when others are greedy and greedy when others are fearful."
C-Trade offers perpetual contracts on the world's most popular crypto assets with the ability to convert trading expenses into investments thanks to its extensive rewards and promotional features. Ready to join the club? Follow the C-Trades Twitter community for the latest updates, platform announcements, etc.
Disclaimer: The content in this article comprises personal opinions and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. C-Trade, its affiliates, agents, directors, officers, or employees do not guarantee the accuracy, validity, timeliness, or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.