November 20, 2020

Derivatives in Crypto

Derivatives in Crypto

Derivatives are very effective financial instruments. Their main advantage is freedom from needing to buy cryptocurrency immediately and keep it in your wallet. Also, traders can minimize risks associated with keeping cryptocurrency in the wallet. Let’s describe what derivatives are, why we need them, and how we can earn money with them. The topic is going to be interesting, let’s start.

Cryptocurrency Derivatives and the Future of Bitcoin

Derivatives definition

Derivatives are the king of financial agreement with information about the future price of a certain cryptocurrency or other financial assets. The subject of this contract is called ‘underlying asset’. There is no subject who is an owner of the cryptocurrency but every counteragent can execute this contract.

Why are derivatives useful?

Traders who trade with derivatives have two main goals:

  1. Decreasing risks
  2. Getting money with price changes.

All kinds of derivatives have these advantages and cryptocurrency derivatives aren’t exceptions. Let’s describe this on the basis of one example.

There is one trader. His name is James. He is afraid that Bitcoin will cost 3 thousand dollars next Tuesday. Yet, there is one way he can reduce these risks. He can create an agreement with another trader. According to it, James can sell his Bitcoins if the price falls to the $3,5 thousand level. This is an example of how derivatives can reduce risks.

Let’s describe one more example. If the second trader wants to buy Bitcoin, keep it until Tuesday, and after that sell this money, he can create a special contract with James and the second trader will be a seller in that case. James doesn’t need to wait for the necessary price to get money. He gets it immediately.

As we see, derivatives aren’t financial assets that require a physical existence of the money in the safe or the wallet. One of the traders can be considered to be an owner and it’s enough. Derivatives can cost similar to the main asset or be cheaper or more expensive depending on a decision that was made by counteragents.


How do people earn money with cryptocurrency derivatives?

Price changes also can change the financial status of cryptocurrency traders. Since we don’t know the future market price of the cryptocurrency, all traders take a risk. If cryptocurrency becomes cheaper at the moment of order execution, only the seller gets an income. The trader who bought the asset, unfortunately, needs to face losses.

Traders can use leverage to increase potential income. At the same time, every trader should understand that risks are also increased. That’s why they need to be attentive and not use leverage until they become real professionals.

The size of leverage is proportional to a deposit. That’s why traders can make orders with huge amounts of money that they don’t have at a certain moment. The maximum size of leverage is set by the broker. A lot of companies take commissions for using leverage.

For example, now Bitcoin costs 8 thousand dollars. James thinks that the price will be falling very soon. He takes one Bitcoin, uses 1:10 leverage and sells 80,000 orders with a price of $8,000 for one Bitcoin. Two hours later, the price of Bitcoin fell to $7,600. Then, he buys cryptocurrency and gets the 0,52 BTC of net income. Now, he has 1,52 times more. However, if the price of Bitcoin grows, it won’t be such a good idea to use leverage because losses can be very awful.

Kinds of Bitcoin derivatives

There are a lot of kinds of Bitcoin derivatives. Every one of them has its own advantages and disadvantages.

  1. This is a kind of agreement for buying or selling the underlying asset at a certain price in the future.
  2. This is a very similar financial instrument, but it has its own advantages. That’s a less standardized asset. For example, you can buy forward without special exchange. However, if we talk about cryptocurrency, traders can also buy forwards on exchanges.
  3. This is an agreement that gives a trader the right to buy the cryptocurrency at a certain price. However, you can choose not to buy the cryptocurrency at this price if you don’t want to.
  4. Improved kind of futures.
  5. This is a contract for the difference in prices of various underlying assets. You can trade these assets as a digital coin.

We see that cryptocurrency derivatives are very promising financial assets. You don’t need to have digital assets if you want to earn money with it. This is a very big advantage.