Derivatives in crypto explained

Experienced traders and investors often use Bitcoin derivatives to make money in the highly volatile cryptocurrency market with less risk. Derivatives themselves are one of the oldest forms of financial contracts in the world, but they are only recently used in the cryptocurrency market and many are still unfamiliar with them. In this article, we would like to introduce you to this financial instrument and tell you about the ways to make money from it. Let’s get derivatives in crypto explained.

What are bitcoin derivatives

Cryptocurrency derivatives are financial contracts that give the participants of the deal certain rights and obligations regarding digital assets. The easiest way to explain derivatives is with a real-life example. Imagine buying any item, such as a book, on a pre-order. When placing such an order, the parties agree in advance on the price and timing of the transaction. Even if the price increases by the agreed upon date, the seller is still obligated to sell the item at a predetermined price.

Cryptocurrency derivatives most often refer to futures, which obligate users to conclude a deal in the future at the terms specified in the contract in advance. But this is not the only type of derivative. Of course, futures are not the only option for digital asset derivatives. But it is important to note that all Bitcoin derivatives have no direct value in and of themselves. The value of derivative assets is based only on expectations about how the price of the digital asset will change in the future. 

Why cryptocurrency derivatives were created

First of all, derivatives help in hedging risks when trading and investing in cryptocurrency. This is one of the best tools when you need to protect yourself from sharp fluctuations in the exchange rate. In this case, a fixed price in the contract allows to mitigate risks and avoid sharp drawdowns.

For instance, the main risk for miners, who mine VTCs, is a sharp drop of the coin’s price, when its production becomes unprofitable. To protect himself, a miner can open a futures on VTS. In this case, if the value of the coin goes down drastically in the future, the futures opened in a short position will allow it to easily level out the losses.

Naturally, derivatives are also a useful tool for earning speculative profits. Some experts even attribute the significant growth in the value of cryptocurrencies in recent years precisely to the emergence of various derivative assets based on cryptocurrencies. The issuance of derivatives for cryptocurrencies is a kind of global recognition of digital assets.