As they become more popular as investment assets and means of exchange in financial activities, digital currencies continue to upend the economy. While you may not be able to trade in actual cryptocurrencies due to a lot of reasons (regulatory measures in a particular region, for example), crypto derivatives are an excellent illustration of a product that has seen and is still experiencing fast growth. Now, what are these crypto derivatives, and how can you pick the right exchange to trade in your crypto derivatives anyway? Let’s find out in this post!
Different cryptocurrency derivatives
A cryptocurrency derivative is, to put it simply, a financial product whose value is based on an underlying crypto asset. In the same way that traditional derivatives operate, a buyer and a seller must engage into a crypto derivatives contract in order to trade in the underlying asset. With derivatives crypto trading, traders agree to trade in the underlying crypto asset at a prefixed date and a set price.
Crypto derivatives rely on the value of the underlying asset rather than having an inherent worth. An Ethereum derivative, for instance, depends on and derives value from the value of Ethereum.
Futures, options, and perpetual contracts are the most common derivatives in the crypto trading space.
The importance of cryptocurrency derivatives
Due to the fact that they serve purposes that go much beyond a single trader’s investment portfolio, cryptocurrency derivatives are crucial to the crypto economy. Why are these products important? Let’s find out!
Increasing liquidity
Cryptocurrency derivatives improve market liquidity, which influences how simple it is for traders to enter or cancel positions. Since there is always someone prepared to take the opposing side of a trade, there is often less risk in a market that is liquid.
Mitigating risks
Due to the extreme price volatility of crypto assets, spot markets always pose an extra set of risks. Cryptocurrency derivatives, on the other hand, can shield a portfolio from unforeseen risk, as they are settled at a future date and time.
Portfolio diversification
With cryptocurrency derivatives, traders have additional alternatives to diversify their portfolios. They have the ability to expand across several crypto assets, since they can use techniques like leverages to invest a very small initial amount in cryptocurrency derivatives.
Improved price discovery
The primary purpose of a market is price discovery, which is the continuous determination of an asset’s current price. By allowing investors to go long or short, cryptocurrency derivatives optimize the process of price discovery.
The goal of cryptocurrency derivatives trading
For beginners, derivatives crypto trading is done either for speculation or hedging.
Hedging
One can utilize cryptocurrency derivatives to safeguard their holdings of cryptocurrencies against unfavorable market changes.
Speculation
If you have a very strong opinion regarding a cryptocurrency’s future, cryptocurrency derivatives are the exact tool for you. With them, you can earn profits from your speculation.
How to Pick the Best Crypto Derivatives Exchange?
Here are a few things you need to be aware of before picking the right cryptocurrency derivatives exchange for yourself:
- Stop-loss and profit-taking
In cryptocurrency derivatives, trades can have a floor price and a ceiling price established using both stop loss and take profit. Depending on the pricing you establish, you can automatically quit the market when circumstances are favorable for you.
- Auto deleveraging (ADL)
A cryptocurrency derivatives exchange’s ADL system has the ability to delete an opposing position from a designated trader in case a position cannot be liquidated at a price better than the bankruptcy price. This usually comes into play in case the insurance is not enough to cover any losses related to the contract.
- Insurance funds
Coming to this feature, insurance funds assist traders with protecting their positions from ADL should the value of their holdings drop below the margin or the maintenance level.
Benefits of using cryptocurrency derivatives
So, what are the advantages of using these products, especially over spot crypto trading?
Market efficiency
Cryptocurrency derivatives contribute to the accuracy of market pricing for underlying assets as well as the market’s stability.
Low transaction costs
In order to lower transaction costs in crypto trading, derivative contracts are useful instruments. Transaction costs in cryptocurrency derivatives trading are lower than spot trading.
Risk management
Cryptocurrency derivatives reduce the risks brought on by the underlying cryptocurrencies’ shifting values.
Higher leverage
As a crypto trader, you can utilize comparatively higher leverages in most cryptocurrency derivatives to raise profit margins, without making a sizable initial investment.
High liquidity
As mentioned before, cryptocurrency derivatives markets are highly liquid. So they certainly bring in a lot of benefits over spot crypto trading.
Conclusion
We do hope this post has given you some insights regarding picking the best crypto derivatives exchange for you. When you are entering the cryptocurrency derivatives market, there is actually no single formula to prevent losses, as you can probably already tell. To protect your money as much as you can, however, do enter the crypto derivatives market only after doing the due research.
There are different types of cryptocurrency derivatives suited to various market conditions as well, and learning about each kind would do you a lot of good.
We wish you luck as you enter derivatives crypto trading!