Bitcoin was first introduced in 2009. It was intended to facilitate financial transaction quickly, cheaply and anonymously. Bitcoin quickly transitioned from a transactional tool to an investment tool which kept growing in value as gained in popularity and people learnt how to invest in cryptocurrency.
Bitcoin futures trading was launched in December 2017. At the time the market had seen a huge bull run with Bitcoin surpassing the $20,000 mark before taking a precipitous drop in 2018.
In an environment of extreme volatility, the introduction of derivatives meant that crypto currency traders could mitigate their risk. By purchasing derivatives, they were assured of receiving the value of the derivative at the conclusion of the contract.
Derivatives attract institutional crypto-investors
More and more organizations are investing in crypto currency. This is confirmed by a Fidelity survey which found that over thirty percent of organisations across the globe now invest in digital derivatives or assets. In the world of cryptocurrencies Bitcoin remains king, but 11% of companies own Ether too.
Futures trading is well understood by financial institutions so these products have had the effect of attracting more institutional funding to the arena. Increased interest in cryptocurrencies will inevitably lead to an increase in value.
What is a derivative?
As financial instruments go derivatives are some of the oldest, going back into early medieval times. Crypto derivatives are trading instruments that help investors to manage their risk and maximise their profits. Derivatives allow you to do more with less.
A derivative is a zero-sum contract between two parties. It is an agreement to buy an asset at a future predetermined price. In the crypto markets, those assets are bitcoin or altcoin futures contracts.
These financial instruments give traders the opportunity to gain exposure to cryptocurrency while efficiently managing their capital. These are hedging instruments that protect investors against price fluctuations.
Cryptocurrencies are highly volatile and can react dramatically to news events. Because they are decentralised, they are not highly regulated, so markets can move in response to manipulation. The main goal of trading in currencies is to maximise profits through efficient trading that minimises risk. Derivatives form an important part of the cryptocurrency trade toolbox as they help investors to mitigate risk and make the most of their investment funding.
Traders can buy crypto derivatives on crypto and regular exchanges. They are traded between traders and on exchanges.
Types of derivatives
- Futures – a contract for an asset bought at agreed prices but paid for at a later date on delivery
- Options – like a futures’ contract, the option allows two parties to agree an asset price up front, but unlike the future the buyer or seller has the right but not an obligation to buy or sell the asset. This depends on whether the option is a call or put option.
- Forwards – Forwards are similar to futures but they’re more flexible and can be customised.
- Quantos – This derivative is used to swap one cryptocurrency for another. It is similar to a futures contract but it doesn’t have a settlement date. Quantos are relatively new in the cryptocurrency markets, and they are fairly risky.
- Perpetual futures contract – similar to futures contracts but on a rolling basis. These contracts can stay open as long as you can afford to keep funding them. The advantage of these instruments is reduction in fees.
- Contract for Differences CFD’s – a CFD is a type of derivative that can give you the benefit of leverage because you only pay a deposit. It allows you to trade on long or short positions and you don’t have to pay stamp duties. Contact Prime XBT and trade on a wide range of markets.
In the future it is likely that there will be an increase in the number of platforms that will trade in derivatives. The availability of derivatives will continue to make cryptocurrency more attractive to institutional investors. Since inception the derivative markets have continued to grow, overtaking the spot markets in numbers of transactions.
Derivative purchases run in the hundreds of millions of dollars and they’re attracting institutional investors.
For those new to crypto derivatives
Derivatives are complex instruments that are difficult for inexperienced investors to navigate. Traders must choose their crypto derivative exchanges carefully. Derivatives are still largely unregulated and there may be unscrupulous dealers out there.
Make sure that you understand the commissions and spreads before you commit. The availability of capped market orders and stop losses are also important considerations when choosing an exchange.