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The advent of crypto has changed the financial game in so many ways. It has made life easier by introducing problem-solving tools that use blockchain technology.
The crypto and stock markets are similar in many ways. Even though crypto dwells on being a digital asset, the operational procedures in trading and making profits are parallel.
Although the crypto CFDs have recorded milestones in success so far, there still needs to be a lot of sensitization to bring more mass adoption. One way this can be done is by cryptocurrency derivatives.
1. What are Cryptocurrency Derivative Products?
Financial experts define derivatives as financial products that depend on other assets to have values of their own. These derivatives could either be a contract or security. Derivatives would be valueless without streams of cash flow or other assets.
The most popular forms of underlying assets where derivatives get their recognition include bonds, currencies, and commodities. These, however, are not the only elements where derivatives obtain their value from. The cost can be tied to almost any asset in existence.
Derivatives can be used for good or bad, and also as speculative tools to enhance economic growth, or they can cripple a financial system as well.
As already mentioned, derivatives have no value on their own. Their value is derived from the speculated price movements of the involved assets.
2. What are the Types of Derivatives?
Derivatives are divided into these categories:
- Futures. This is the most prevalent of all crypto derivatives. In a crypto futures trade, two parties agree to purchase or sell assets on a specified date for a pre-determined amount. The futures are traded on exchanges and contracts. They are, therefore, standardized and similar. Crypto future contracts are more like wagers on an underlying asset. They present a valuable hedging opportunity.
- Forwards. Forwards are similar to futures but can be tailor-made to suit the trader’s needs. Forwards offer a significant advantage in flexibility. They are usually traded via OTC (Over the Counter). It is, therefore, necessary to consider the various risks associated with forwards.
- Options. Options enable a buyer or seller to make transactions using a certain asset at a pre-established price while working with a particular timeline. The trader doesn’t have the mandate to buy the asset according to the contract. This is the main difference between options and futures.
- Swaps. Just as the name suggests, swaps are used to exchange one type of crypto with another to make a profit at a pre-determined time in the future. The assets traded can be bonds, loans, or notes. They are exchanged by switching from a specific interest rate to a variable interest rate or vice rate.
- Perpetual Future Contracts. Perpetual future contracts operate like traditional crypto future trades, but for one thing, they don’t expire. Perpetual futures contracts give benefits either way. They allow traders to be intuitive of spot market trading while maintaining the benefits of the futures market, like leverage and risk hedging. Traders can hold the contract for as long as they wish and close it at any time. These contracts are risky as they are used as a funding mechanism. They have to be traded with extra care.
3. How are Derivatives Used in Crypto Trading?
As cryptocurrencies continue to take the world by storm, traders continue to make the most out of price fluctuations when they enjoy significant profits.
Once Bitcoin and altcoin futures were introduced in the market, traders got a new tool to mitigate risks by merely signing a contract. Traders use this to make a profit by identifying a cryptocurrency with low value, buy it then sell it when its price increases. However, note that this strategy is risky. If you have to use it, then you should use it during a bullish marketing trend.
You can also use another strategy called shorting to make profits even when the market is on a downward trend. It involves borrowing assets from a third party like a broker or an exchange, such as Pepperstone, then selling them when they predict the price will fall. When the price drops, the trader rebuys the same assets at a lower price. As the price fluctuates, they make profits. The third-party then receives a commission.
Analysts and experts have predicted that derivatives will continue to increase in popularity as traders can now choose between trading cryptocurrencies or fiat. This shows that the crypto market is more than ready to accept derivatives.
Cryptocurrency derivative products are a way to increase sensitization for mass adoption. Derivatives are products that get their value from other assets. Such assets include currencies, commodities, and stocks. Derivatives in cryptocurrencies include futures, options, swaps, forwards, and perpetual future contracts. The crypto market is ready to accept more derivatives because of its increased popularity.