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Crypto Derivatives 101: A Beginner’s Guide To Futures, Options & Swaps

Crypto Derivatives 101: A Beginner’s Guide To Futures, Options & Swaps
Written by publisher team

The world of cryptocurrency trading has long evolved from the basic concept of buying, selling and holding. These days, smart money does more than just invest and hold coins that you think are most likely to double in value. Smart money sees greater gains to be made from entering the world of crypto-derivatives, which offer distinct advantages over basic trading.

Cryptographic derivatives

In simple terms, a crypto derivative is a financial contract between two or more parties, in which the value of that contract is derived from the underlying asset on which it is based. The contract itself is an agreement to buy that specific asset – be it Bitcoin, Ethereum, or some other cryptocurrency – at a predetermined price at a specific time in the future.

The crypto derivatives market has three popular products, namely cryptocurrency futures, crypto options, and cryptocurrency swaps.

Cryptocurrency futures contracts

The first crypto derivatives market to go mainstream was the futures market, which is still the most traded volume by volume.

Cryptocurrency futures are the basic type of contract, similar to what was described above. When entering into a cryptocurrency futures contract, the first thing a trader needs to determine is the term of the contract. Most exchanges offer several options, such as weekly, bi-weekly, monthly or quarterly contracts. Suppose our trader wants to open a weekly BTC contract, each contract is worth $1 when the bitcoin price is $10,000, that means he needs 10,000 contracts.

The trader then has the option to buy, bet the price will go up, or sell, betting that the price will go down by the time the contract expires.

When the trader opens his position, the exchange will match that contract with someone who bets on the opposite outcome. When the contracts are settled after one week, one trader will have to pay the other. So if our trader decides to go short and the price of BTC drops, they will make a profit. However, if the price goes up, it will cause our trader to lose.

Where do you trade cryptocurrency futures?

One of the best platforms for cryptocurrency futures SynfuturesIt is a next-generation derivatives platform based on smart contracts that maintain liquidity reserves, and operate according to specific pricing mechanisms. The great advantage of SynFutures is that it uses a synthetic automated market maker, which enables participants to provide only one asset of their trading pair, while synthesizing the smart contract for the other. It also uses automated liquidators to automate the filtering process, thus reducing the liquidators’ entry barrier.

Another unique feature of SynFutures is that it allows futures contracts on non-fungible tokens allowing traders to bet on the prices of multiple types of NFTs without having to own these assets.

Encryption Options

Options contracts are similar to futures contracts in that they also track the price of a specific cryptocurrency, however, they differ in that they do not have to be settled on their expiration date. Instead, traders have the option to buy or sell at predetermined prices on specific future dates.

With cryptocurrency options, investors don’t make buying or selling but rather “buying” or “selling”. The ‘call’ option refers to the trader’s right to buy BTC at an agreed-upon price when the contract expires, while the ‘put’ option gives the other party the right to sell at the agreed-upon prices. In either case, it is up to the trader to decide whether or not he wishes to exercise his right to buy or sell.

Suppose our trader buys a BTC call option at $10,000 and it expires in one week. This means that they will have the option to buy 1 BTC for $10,000 (known as the “strike price”) exactly one week later. If the BTC price has since risen to $12,000, the trader will likely want to exercise the call option and buy BTC at a cheaper rate, as this means that they can sell immediately for a profit of $2,000. Alternatively, if the price drops below $10,000, the trader will most likely allow the option to expire, because buying at that price means losing money.

This does not mean that crypto options are a risk-free method of trading, as traders have to pay a premium to conclude each contract. The premium varies from exchange to exchange but must be paid regardless of whether the trader decides to call or sell.

Where do you trade crypto options?

The popular crypto options trading platform is DerptWhich offers hundreds of cryptocurrency trading pairs with daily cash settlement in BTC and a maximum of 1,000,000 contracts, worth up to $10 million. Traders are allowed to benefit from up to 100x leverage when trading BTC options, with an additional fee of just 0.04% or the underlying contract. In addition, users can also test their trading strategies on the Deribit test network with up to 10 BTC of demo money.

Crypto swaps

Cryptocurrency swaps, also known as perpetual contracts, are futures contracts that come with no expiration date. Since there is no expiration date, neither party has to buy or sell. Alternatively, they can keep their positions open as long as they have the funds to cover this contract.

The main difference with swap contracts is that, unlike standard futures contracts where the price of the underlying asset and the contract converge on the expiration date, a different mechanism known as the “funding rate” is used to force the price convergence.

A finance rate is a fee exchanged between two parties to a contract, as opposed to the fee collected by the exchange. The financing fee rate varies, is determined by the market, and acts as a balance to ensure that when the value of the contract continues to rise, deals have an incentive to keep the contract open. So for example, if the swap contract is trading at $9,000 but the spot price of Bitcoin is $9.005, the funding rate will be negative to calculate the difference, which means that the short party to the contract has to pay to the holder of the long contract. However, if the contract price is higher than the spot price, there will be a positive financing rate, which means that the holder of the long contract must pay the short-selling holder.

Either way, the funding rate helps encourage traders to open new trades that can help bring the contract price closer to the spot rate.

On most exchanges, swap funding price payments are made every eight hours as long as both parties keep their positions open. On the other hand, profits and losses are settled daily and credited to the merchant account automatically.

Where do you trade cryptocurrency swaps?

Cryptocurrency swaps are less common, with BitMEX Being one of the few platforms to offer contracts in Bitcoin, Ethereum, Cardano, Bitcoin Cash, Litecoin and XRP. One of the things that sets BitMEX apart are the rebate fees for makers and miners, with a maker fee of -0.025 BTC and -0.05% on other coins, and an order fee of 0.05% for BTC and 0% for other coins.

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