Speculators and proponents of aggressive investment strategies widely use standard exchange-traded and over-the-counter derivatives to generate profits. Many are also seriously interested in assets like crypto derivatives (derivatives on cryptocurrencies).
From this article you eill learn:
- Major exchanges like CME and Binance offer a range of crypto futures, with non-standard options like perpetual futures also available.
- Investors can trade crypto futures, options, and CFDs, leveraging these instruments for speculative gains or risk hedging.
- Both institutional clients and retail investors can engage in crypto derivative trading, though offerings and risks may vary by platform and regulatory environment.
What Are Crypto Derivatives and Where Are They Traded?
Crypto derivatives are a broad term for futures contracts (derivative financial instruments) where the underlying assets are cryptocurrency rates. Most of these contracts are settled, meaning they do not involve the actual transfer of tokens but rather provide the opportunity to profit from the price movements of the cryptocurrency. This can indeed interest traders engaged in speculative operations and aggressive investors due to the high volatility in the crypto market.
The range of these derivatives includes the same instruments used with assets from other markets, such as stock, currency, or commodities:
- A futures contract obligates one party to buy and the other to sell a specified amount of cryptocurrency at a predetermined price after the contract’s expiration. In the case of a settled future, one party pays the other the difference between the purchase price and the current price at settlement (expiration). A futures contract is standardized and traded on exchanges. The transaction is conducted with a Central Counterparty, guaranteeing the fulfillment of obligations by both parties. One of its most attractive features is the requirement to deposit only a margin, which can range from 2% to 20% of the contract’s total value, making it effectively a leveraged transaction with potentially unlimited returns (and risks).
- These are similar to futures but are over-the-counter contracts. They also obligate both parties to complete a future transaction with cryptocurrency under agreed-upon terms. The main difference from futures is the lack of standardization, execution without a central counterparty, and no margin requirements, significantly increasing the risk for the participant. Forwards are used much less frequently than futures, typically by investors interested in the actual purchase of crypto assets.
- This type of contract gives the buyer the right, but not the obligation, to buy or sell cryptocurrency at an agreed-upon price upon execution. The seller (writer) of the option is obliged to fulfill the transaction upon the buyer’s request. This instrument is especially popular among speculators because the buyer’s risk is limited to the premium paid to the seller, while the profit potential is unlimited. Both standardized exchange-traded options and OTC options, where all deal details are negotiated between the parties, are available in the market.
- CFDs (Contracts for Difference). These are derivatives that represent an agreement where the parties settle the difference in prices between the time of contract inception and execution. If the price rises, the buyer profits, and the seller makes the payment. Conversely, if the price falls, the financial flow reverses. Essentially, such contracts are similar to spot transactions but can have a specified execution period. Another crucial difference is the use of leverage, which can be significantly higher in the derivatives market than in unsecured margin transactions on the spot market.
Today, finding options for trading crypto derivatives is not an issue even for retail investors.
Platforms for Trading Cryptocurrency Futures
As early as 2017, the Chicago Mercantile Exchange (CME) launched trading of standard Bitcoin futures. Since February 2021, Ethereum futures have also been traded there, and since May, Micro Bitcoin Futures with a base asset of 1/10 BTC. This allows investors to invest in crypto assets without the need for actual token exchange, managing wallets, or worrying about security.
Futures contracts are available on almost all major crypto exchanges (for example, Binance has a separate section called Binance Futures). Contracts are made on the rates of most listed cryptocurrencies paired with fiat currencies or other tokens.
Many crypto exchanges offer non-standard futures contracts, such as perpetual futures. These are exclusively settled contracts where the investor realizes profit or loss by closing (selling the bought or buying the sold) futures at any given time. These derivatives share all the typical features of standard futures, from margin requirements to the calculation, accrual, and deduction of variation margin.
Trading CFDs on Cryptocurrencies
Many licensed forex dealers now offer contracts for differences (CFDs) on cryptocurrency assets. They can also be found with dealing centers that do not have licenses from official regulators but have been successfully providing trading services on interbank and over-the-counter markets for many years (e.g., Alpari, ForexClub, etc.).
Legislation regulating digital asset trading has not been adopted in most countries. Therefore, even licensed companies often operate through subsidiaries registered in offshore jurisdictions where the requirements for financial services and their quality are significantly more lenient.
Regarding other types of crypto derivatives, they are not yet as widespread:
- In 2019, Fortex Technologies, known for its institutional solutions for the Forex market, announced the launch of a platform for concluding settled forward contracts. These contracts will only be available to institutional clients.
- The most well-known platform for trading options on Bitcoin and Ethereum is the Deribit derivatives exchange, which has been operating since 2016. A simplified version of standard exchange-traded options is offered by Binance on its Binance Options platform. These are perpetual options with no expiration date, allowing traders to act only as buyers.
Use of Crypto Derivatives
The primary users of cryptocurrency derivatives are traders engaged in speculative trading. Aggressive investors also use them to increase returns. The main instruments for such market participants are futures, CFD contracts, and options.
Crypto derivatives are also often purchased as hedging instruments. They are used in this capacity by:
- More conservative investors with portfolios partly invested in crypto assets. Buying options can be a good solution, providing a hedge against declining prices.
Miners and owners of mining farms, for whom a put option can be an excellent hedge for business profitability during periods of falling prices.