What are the Crypto Derivatives and their Types: Explained Here

The worldwide crypto asset markets now include a sizable portion of crypto derivatives, which allow traders to hedge their exposure to the market or speculate on price volatility. Cryptocurrency derivatives function similarly to conventional financial market derivatives. A contract between two parties lays down the terms and conditions, such as the amount, price, and duration of validity, for the purchase or sale of the underlying asset.

With the use of leverage, seasoned digital asset traders can implement cutting-edge trading tactics thanks to cryptocurrency derivatives. They can also be used to hedge huge positions in specific crypto assets or portfolios of digital assets.

Also Read: How Digital Currency Reshaping the Future Economy of Gig Market like Freelancing

Top Crypto Derivatives Exchanges by Market Share (March 2023)

• Binance dominates the crypto derivatives exchange market with a commanding 59.8% market share.

• OKX holds the second position with a market share of 17.2%.

• Bybit follows closely behind in third place with a market share of 13.2%.

• Kucoin secures the fourth position with a market share of 2.9%.

• Gate.io ranks fifth with a market share of 2.5%.

• Dydx occupies the sixth position with a market share of 1.5%.

• Huobi holds a market share of 1.0%, placing it in seventh place.

• Deribit follows closely behind with a market share of 0.9%.

• Bitmex ranks ninth with a market share of 0.8%.

• Crypto.com rounds up the list with a market share of 0.2%.

Source: Coingecko.com

Also Read: What is a crypto trading bot and how does it work?

Types of Crypto Derivatives

In the cryptocurrency markets, derivatives contracts mostly fall into three categories: perpetual swaps, options, and futures.

Futures 

Futures are financial derivatives contracts that impose an obligation on the buyer or seller to purchase or sell the underlying asset at a prearranged price at a later date. With cryptocurrency futures, you can use leverage to go long or short in a crypto asset, hedging your exposure to the market or making predictions about future price movements. It is known as entering a long position to buy futures contracts and entering a short position to sell futures contracts. 

Let’s take an example where Trader A purchases a crypto futures contract for $1,300, with ETH as the underlying asset. Trader B is the other party to the trade; he is a short seller in the trade. We overlook the impact of margin and leverage in the interest of simplicity.

Options

The option holder retains the choice to exercise the option, upon which the option seller is obligated to fulfill their contractual commitment. You can use cryptocurrency options, just like futures, to hedge your exposure to the digital asset market or speculate on price swings.

• Long call option: Since one might hypothetically exercise the option to purchase the asset at the lower strike price and sell it at the higher market price, it would benefit when the market price is comparatively higher than the strike price (and the premium). One would forfeit the premium paid if she or he did not exercise the option and the market price fell below the strike.

Source: Crypto.com

• Short call option: Earnings are capped at the amount of the premium that was sold with the option. When the market price exceeds the strike (plus the premium), losses happen.

Source: Crypto.com

• Long put option: Theoretically, one might purchase the asset at the lower market price, exercise their option, and sell it at the higher strike price, so it makes profit when the market price is lower than the strike price (minus the premium). One would not exercise the option and would forfeit the premium if the market price was higher than the strike.

Source: Crypto.com

• Short put option: Earnings are capped at the amount of the premium that was sold with the option. When the market price (minus the premium) is lower than the strike, losses happen.

Source: Crypto.com

Perpetual Swaps

Financial derivatives called perpetual swap contracts let you use leverage to speculate on how the price of cryptocurrency assets will fluctuate. But perpetual swaps have no expiration dates, in contrast to conventional futures contracts.

A funding rate mechanism is used in perpetual swaps to assist in guaranteeing that the contract price corresponds with the price of the underlying asset. The funding rate is the difference between the spot price of the underlying asset and the trading price of the contract.

Because it provides incentives for the less popular market side, the structure maintains a balance between the demand for long and short positions. 

For instance, long position holders are charged for the funding rate, which they pay to traders in the short position, if the price of a perpetual swap is higher than the current price of its underlying asset.

Also Read: What is Bitcoin Halving and How Is It Done?

Conclusion

Cryptocurrency derivatives are sophisticated, tradable financial products that are usually utilized by experienced traders. A fundamental asset, such as (but not limited to) cryptocurrencies, stocks, bonds, commodities, and FX, is the source of their value. Without really owning the digital asset, traders might be exposed to price fluctuation through contracts for cryptocurrency derivatives. Futures and options are two popular forms of cryptocurrency derivatives that are mostly utilized for speculating and hedging. The suitability of cryptocurrency derivatives is contingent upon the specific knowledge, skill level, and circumstances of each trader.