Conventional crypto trading sites have now expanded their range of trading choices to include more sophisticated alternatives, such as trading in crypto derivatives.
These instruments have generated millions and billions of dollars in revenue: in March 2023, the crypto derivatives market size reached 74.8% share of the total transacted volume of $2.95 trillion in the crypto market.
Due to their increasing popularity, many new businesses and entrepreneurs are venturing into the creation of crypto derivative trading platforms.
The major online venues for purchasing and selling digital assets have a significant influence on crypto trading as a whole, playing a crucial role in the crypto industry.
In this article, we will discuss this type of derivative contracts, its features and benefits, and explore the phenomenon of crypto derivatives exchange development.
A crypto derivative is a tradable security based on the future price of an asset.
Examples of crypto derivatives are perpetual swaps, forward contracts, futures contracts, and options contracts.
Crypto derivatives exchange development involves creating software for managing and running platforms for crypto trading on contracts.
A good crypto derivative exchange should be secure and transparent and have a competitive fee structure.
What Are Crypto Derivatives?
A crypto derivative functions as a tradable wager on the future market price of an asset. These arrangements are akin to betting on the price motion of a virtual currency. Individuals can speculate on the price of cryptos without the necessity of buying or selling the coins themselves.
Virtual money derivatives function similarly to traditional derivatives in financial markets, with contracts specifying purchase or sale conditions, validity period, price, and quantity.
They enable experienced traders to execute advanced trading strategies using leverage and can be used to hedge digital asset portfolios or large long positions in a crypto asset. For instance, Bitcoin mining companies may sell Bitcoin options to protect their natural long position.
Market share of crypto derivatives
Crypto derivative instruments offer several benefits, including leverage, risk management, and the ability to execute complex trading strategies.
They let traders enter larger positions than their capital would allow in the spot market and can be used to hedge digital asset market exposure, reducing market risk and market sentiment.
However, leverage can also amplify losses, as the volatile nature of virtual coins can lead to significant damage if not adequately hedged.
Additionally, over-the-counter (OTC) derivatives trade faces default credit risk and lack of due diligence and transaction security exchanges.
Crypto derivatives have traditionally been traded on centralised exchanges due to their liquidity and responsive trading environment.
However, allegations of abuse and potential offline trading during major market events have led to concerns about the safety of customers.
As DeFi matures, there are now a few viable decentralised derivatives platforms, although they still lack centralised exchanges’ liquidity depth and responsiveness. However, these differences are expected to narrow over time.
Crypto derivative trading operates similarly to derivative trading but focuses on trading crypto assets. The Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange (CME) have introduced digital currency derivatives trading options, which have attracted global traders.
Exchanges like Binance and Bybit also offer crypto derivative trading options. The feature is accepted between admins and traders through contracts that can be used for hedging or speculation.
Hedging involves mitigating future risks, while speculation involves predicting and mitigating risks. This feature has helped increase the user base and attract global traders.
According to Coinmarketcap, Binance is the biggest crypto derivatives exchange with a derivative trading volume of over $43 million.
Fast Fact
Types of Crypto Derivatives
Crypto derivatives are financial contracts whose values are determined by the price movements of underlying crypto or their associated assets. Common types include the following.
Crypto Derivatives Types
Futures Contracts
Engaging in crypto futures means agreeing to buy or sell an agreed quantity of virtual currency at a fixed price on a specified future date. These contracts let traders bet on the price of digital assets without owning them, and they can make money if the price goes up or down.
Options Contracts
Options are derivative contracts that grant the right to buy or sell an underlying asset at a predetermined price in the future. The buyer enjoys the right, while the seller has an obligation to fulfil their part if the option holder chooses.
Crypto options can be used to speculate about price movements or hedge digital asset market exposure. However, options offer more flexibility than futures as they are not obliged to exercise the option.
Options come in call and put variants: call options allow the holder to buy crypto at a predetermined price, while put options allow the holder to sell at a predetermined price.
For instance, a trader might purchase a Bitcoin call option with a strike price of $100,000, which expires in three months. If BTC exceeds $100,000 before expiry, they can buy at a lower price and potentially profit.
Perpetual Swaps
Perpetual swaps are financial derivatives that allow traders to hold positions indefinitely without the need to roll over contracts. They don’t have expiration dates like traditional future contracts and use a funding rate mechanism to maintain the contract price close to the spot market.
The funding rate is determined by the difference between the contract’s trading price and the underlying asset’s spot price. This structure balances demand for long and short positions by offering incentives for the less popular market side.
Forward Contracts
The forward contracts are similar to futures contracts. They allow customisation based on the needs of both parties, enabling both buyers and sellers to customise the contract and underlying asset.
With forward contracts, two parties exchange cryptos or assets at a predetermined price, allowing them to hedge against potential asset price fluctuations and future exchanges.