Crypto derivatives are special agreements based on the value of a Cryptocurrency. Instead of buying the actual cryptocurrency, people use these agreements to speculate on their future prices.
Perpetual Contracts
Perpetual contracts are a kind of a Crypto derivative that allows traders to speculate on the future prices of an asset without an expiration date.
Example
A. Buying Scenario
Trader A believes that the price of Bitcoin will increase
They enter into a perpetual contract to buy (go long) one Bitcoin at the current price of $50,000
If the price rises to $60,000, Trader A can close the contract, making a profit of $10,000 (excluding fees and funding costs)
B. Selling Scenario
Trader B anticipates a decrease in the price of Bitcoin.
They open a perpetual contract to sell (go short) one Bitcoin at the current price of $50,000
If the price drops to $40,000, Trader B can close the contract, making a profit of $10,000 (again, excluding fees and funding costs)
In both cases, the traders are speculating on the price movement without a fixed contract expiration.
Other Types of Crypto Derivatives
Futures Contracts
Futures contracts are agreements between two parties to buy or sell an asset at a predetermined future date for a price agreed upon today.
Unlike perpetual contracts, Futures contracts have a specified expiration date, after which the contract must be settled.
Options Contacts
Crypto options give the buyer the right (but not the obligation) to buy or sell the underlying asset at a predetermined price within a specified time frame. There are call options (to buy) and put options (to sell).
Swaps
Crypto swaps involve the exchange of cash flows between two parties based on the movement of cryptocurrency prices. Common types include interest rate swaps and total return swaps
Pros and Cons of using Leverage
Perpetual and Futures contracts allows traders to control a large position with a relatively small amount of capital, which is known as leverage. This magnifies both potential gains and losses.
Pros
Magnified profits
Risk Management
Enhanced Trading Opportunities
Cons
Increased risk of loss
Increased rates and fees
Margin calls
Closing Thoughts
Trading Crypto derivatives has higher risks compared to spot trading. Have a clear risk management strategy, and be aware of the potential for both gains and losses.
