In the previous lessons, we learned about the different trading venues and the concept of spot trading and how to do it. Next, we will explain what cryptocurrency derivatives trading is.
Derivatives and Derivatives Trading
Derivatives were popular in the traditional financial industry long before cryptocurrencies were created. As a special class of traded financial instruments, derivatives have a wide range of underlying assets, including stock interest rate indices, stock indices, currency indices, etc.
Derivatives in the traditional financial industry include futures, options, warrants, forward contracts, swap contracts, etc. These different derivatives have their own trading methods and uses. With the birth and development of cryptocurrencies, there are also several more common derivatives in the cryptocurrency market, such as futures contracts, perpetual contracts and option contracts.
Unlike spot trading, derivatives trading offers the option of leverage, allowing investors to borrow leverage to trade on margin and thus expand their potential profits. However, trading on margin (i.e., the user trades with borrowed funds) increases investment risk, i.e., the possibility of liquidation of the margin. As a result, derivatives are also considered high-risk assets.
Derivatives Trading in Cryptocurrency
Futures Contracts
A futures contract is a margin trading transaction conducted through leverage. Futures contracts allow investors to take higher risks while gaining from the price fluctuations of different underlying investments. Margin trading uses the principle of leveraged investment, which allows for the use of small amounts of capital as collateral to amplify potential profits while trading, allowing even small investors to trade with high returns in the financial markets. However, it is important to note that futures contracts can also magnify the risk of potential losses.
Unlike spot trading, when trading contracts on the futures market, no transfer of the underlying asset actually takes place. When trading a BTC/USDT contract, the trader is not actually buying or selling BTC, but rather trading based on the projected value of BTC. That is, the trader is betting on the price movement of BTC parallel to the value of the contract, without owning the BTC asset.
Simply put, the contract acts as a cryptocurrency derivative that allows users to gain from rising or falling digital asset prices by judging the ups and downs and choosing to buy long or sell short the contract.
Perpetual Contracts
A perpetual contract, or perpetual future, is actually a type of futures contract, but unlike traditional futures contracts with a delivery date, a perpetual contract has no delivery date and traders can choose to hold it for as long as they wish. The perpetual contract is also an attractive derivative for traders looking to hedge their spot positions or to speculate on various asset prices.
The perpetual contract is currently the dominant derivative traded on many cryptocurrency exchanges, with some offering leverage of up to 125x.
Option Contracts
An option contract is a derivative that gives a trader the right to buy or sell an asset in the future at a specific price. Unlike a futures contract, however, there is no obligation for the trader to settle the contract between options contracts.
Option contracts, or options, are actually very similar to futures, as they both include an agreement between two parties to buy and sell a specific cryptocurrency at an agreed-upon price and date. But the holder of an option contract does not necessarily have to exercise his or her right to buy or sell on the expiration date. To enter into an options contract, traders must pay a margin. If they do not want to exercise their rights at the end of the contract, they must still pay the margin.
Options contracts can be divided into two main types: call options as well as put options:
Call option: A call option allows you to buy a specific amount of a certain cryptocurrency at a specific price for a certain period of time or point in time in the future.
Put option: A call option allows you to sell a specific amount of cryptocurrency at a specific price within a certain period of time or at a certain point in time in the future.
Summary
For beginners who are new to cryptocurrencies, spot trading, which is easy to get started with, is probably the most appropriate way to go. For experienced traders who are willing to take risks for high returns, including perpetual contracts would be a relatively suitable option.
Disclaimer
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Crypto investment involves significant risks. Please proceed with caution. The course shall not be considered investment or financial advice.