Even though the market for crypto derivatives is growing, the instruments and infrastructure that support them are not as developed as those in traditional financial markets. We think that 2022 will be when crypto derivatives reach a new growth and market maturity level.
Many infrastructures have been built and improved in the last year, and more institutions are getting involved. From the latest trends, more sites are now accepting crypto payments, for example, if you look at how to pay for NFL picks or how to make a secure international transaction, you will see cryptocurrency as an option, same as fiat.
This article talks about the current state of the market, key infrastructure developments that we think will spur growth, and areas where we expect growth.
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What is Derivative Trading?
The value of a derivative contract or product is based on the value of an underlying asset. All derivative assets are currency exchange rates, commodities, stocks, interest rates, and stock prices.
Both the buyer and seller of these contracts have made predictions about future trading prices that are entirely different. Both sides bet on the future value of the underlying assets to make money.
What is Derivative Trading in Crypto?
Any cryptocurrency token can be used as the base asset in crypto derivatives trading. When two people make a financial deal, they bet on how much cryptocurrency will be worth in the future.
During the first part of the contract, the parties agree on a price to sell or buy the cryptocurrency on a particular day, no matter the market price. So, investors can profit from changes in the cost of the underlying asset by purchasing the currency at a low price and selling it at a high price.
How Big is the Derivative Market in Crypto?
According to Tokeninsight’s Cryptocurrency Derivatives Exchange Industry Report, the trading volume in the cryptocurrency derivatives market for the third quarter of 2020 was $2.7 trillion.
This number was based on data from 42 exchanges. This is a 25.1% increase from the previous quarter and a 159.4% increase from last year. This shows how much crypto-derivatives have grown during the last few years.
What Are Some Derivative Trading Features?
Stop/Loss Take Profit: This feature lets traders set the minimum and maximum prices for an order, getting out of the market automatically when conditions are good.
Auto Deleveraging (ADL): When a position can’t be sold for less than the bankruptcy price, and there isn’t enough insurance to cover the contract loss, your crypto exchange’s ADL system will automatically delete an opposing position from a designated trader.
Insurance Funds: Even if their holdings drop below the maintenance margin level, insurance funds still help traders avoid auto-deleveraging.
Partial Close Orders: This feature lets traders take part of their profits while still benefiting from an expanding market.
What Are the Most Popular Types of Derivatives in Crypto?
Crypto derivatives can be any of the following, depending on the terms of a contract:
Swaps; Swaps are agreements between two parties to trade cash flows later based on a formula that has already been set. They are over-the-counter (OTC) contracts that are not traded on exchanges like forwards.
Futures; A futures contract is a legal agreement between two parties to buy or sell an underlying asset at a specific price and date. The contract is made directly on an exchange that is regulated.
Options: An option contract gives a trader the right, but not the obligation, to buy or sell an underlying asset at a specific date and price in the future.
Perpetual Contracts; Unlike futures and options, perpetual contracts don’t end or settle on a specific date. Under certain conditions, traders can keep their positions open for as long as they want (for example, if the account holds a certain amount of a cryptocurrency).
What Are the Advantages of Using Derivatives?
Low transaction costs: Since derivative contracts are tools for managing risk, they help keep market transaction costs low. Because of this, the prices of trading derivatives are lower than other types of trading, such as spot trading.
Used for risk management, the value of a derivative contract is directly tied to the value of the crypto coin or price token that it is based on. So, derivatives are used to reduce the risks that come with the prices of underlying assets changing.
Mr. A, for example, buys a derivative contract whose value goes in the opposite direction of the value of the crypto-coin or token he owns. He will be able to make up for losses in the original crypto coin or token with gains from derivatives.
Market efficiency: Arbitrage is a part of derivative trading, which is vital for ensuring that the market finds equilibrium and that the prices of the underlying assets are correct.