As the worldwide cryptocurrency markets have experienced stagnation for over a year, a significant transformation is occurring within the market and its wider ecosystem. This shift includes the emergence of mainstream institutions and fintech startups, which facilitate cryptocurrency trading anytime and anywhere. Furthermore, a dynamic derivatives market for cryptocurrencies is being developed.
Derivatives, by definition, are financial contracts that obtain their value from the price of an underlying asset, including stocks, bonds, commodities, indices, currencies, and more. The same principle applies to cryptocurrencies, as investors and traders can purchase futures and options contracts based on digital assets, with predetermined expiry dates and various purposes.
Understanding Different Derivatives Contracts
Before delving deeper, let’s briefly explain futures and options contracts, the two most common types of derivatives contracts. Futures contracts are agreements between two parties to buy or sell an underlying asset at a predetermined price on a specified future date. The contract’s value fluctuates depending on the underlying asset’s price, potentially resulting in profit or loss for the involved parties.
In contrast, options contracts do not obligate the buyer to buy or sell the underlying asset on a specific date. There are two types of options contracts: call options, which grant the contract holder the right (but not the obligation) to purchase the underlying asset within a certain timeframe, and put options, which allow the holder to sell the underlying asset at a specified price within a given period.
Why Choose Crypto Derivatives Over Spot Trading?
Derivatives contribute greatly to financial markets, offering speculation, hedging, diversification, and leverage opportunities. Despite their inherent risks and challenges, the establishment of a strong derivatives market for cryptocurrencies is a positive development that paves the way for institutional capital and trading activity in the future.
Here are a few reasons why crypto derivatives are preferable to spot trading for investors and traders:
Futures and options offer investors high levels of leverage, amplifying gains with even slight price movements in the underlying asset. However, leverage is a double-edged sword; it can boost gains but also potentially eliminate an entire investment. As such, it is best suited for seasoned traders with a comprehensive understanding of market conditions.
Options and futures contracts enable investors to hedge against risks associated with their existing positions. In the increasingly volatile cryptocurrency market, hedging is crucial for safeguarding investments against unforeseen events.
Beyond speculation and hedging, traders can earn income by selling or writing derivatives contracts and collecting the resulting premiums. This is similar to an insurance company collecting premiums for covering potential events. If the event does not occur, the insurance company retains the entire premium.
The global crypto market is undergoing significant changes and adjustments. Ultimately, we anticipate that the market will become more efficient, comparable to traditional financial markets in terms of depth, liquidity, and volatility. The emergence of derivatives and derivatives exchanges is a critical step in this direction, poised to revolutionize the crypto markets as we know them.