What are derivatives?
The fact that cryptocurrencies are becoming a civilized market is confirmed by the fact that they are traded on exchanges, and just as with the usual currencies, commodities, and stocks, digital assets have similar derivatives
Cryptocurrencies have already firmly entered our lives. Many countries are issuing their own currency, developing their own financial sphere. .
One can take cryptocurrency derivatives as an example, with the most famous being Bitcoin futures. Let's consider the principle of their work in more detail.
What is a derivative?
A derivative is a financial tool. Simply put, it is a contract between two or more parties that gives the right or obligation to buy a cryptocurrency at a pre-fixed price. Its value is calculated based on the price of a particular cryptocurrency. The derivatives themselves have no value. Their main value lies in what movements in the value of coins await in the long run. Contracts are divided into three types: options, futures, and swaps. Let's look at it in more detail:
- Option. This is a contract that gives you the right, but not the obligation, to buy goods at an agreed value (also called a call option). And there is another type, called a put option, which allows you to sell at a pre-determined price. The main advantage of options is that when the two parties combine, one of them can make a decision after the expiration of the contract. However, the party that has this privilege pays a certain fee for this opportunity.
- Futures. Their peculiarity is that they regulate the sale of assets on prospective data, but at a price that was determined at the moment. Such contracts have weight on cryptocurrency trading platforms, where the exchange acts as an intermediary. Once the agreement is made, it is no longer possible to make adjustments. Contracts are made solely in a certain type and volume for a period of time. When working with futures, the buyer and seller make an agreement with the exchange, not with each other.
- Swaps. They are rightfully considered the most complex on the market. The parties can use them to exchange cash flows. A popular example is swapping a fixed rate for a variable one. With the help of swaps, companies can reduce the percentage of cash risks, that's why this type of contract is very popular. Traditionally, agreements are made between individuals who do not use the services of an exchange. Investment banks most often take on the duties of intermediaries.
Why use derivatives?
With the help of derivatives, financial markets gain additional benefits. Of these, the following stand out in particular:
- Opening up access to closed assets and markets. Contracts allow organizations to gain exposure to closed exchanges or inaccessible currencies.
- Assigning value to major coins. One example is futures, whose price can reflect the exact value of goods.
- Increasing the efficiency of trading platforms. Members of the cryptocurrency community are almost unanimous in believing that interaction with cryptocurrency derivatives actively helps to increase the effect of the financial market. Agreements can be used to re-pay assets, which contributes to the equilibrium between the asset and the derivative product associated with it.
- Risk insurance (hedging). The income from a futures contract can cover the losses of the main coin. For example, a depositor opens a short position on a futures contract for a cryptocurrency. If the price of the currency falls, the income from the futures contract will compensate for the loss.
- Preventing volatility. Any market player, whether an individual or a legal entity, is trying to protect themselves from the risks associated with sharp price fluctuations.
Next to the advantages, there are disadvantages, which were the reason for the crisis in 2007-2008, a few years before the birth of the first cryptocurrency. The main disadvantage is significant volatility. Derivatives are difficult to evaluate, so the risks are quite serious. If one considers cases of unreasonable use, one can incur large losses due to speculation. And finally, there is the possibility of default of intermediaries. The peculiarity is that not every agreement is subjected to due diligence in the financial market.
Today we have a rich and diverse cryptocurrency market with more than two thousand different tokens and electronic coins. Not so long ago, cryptocurrency trading platforms began to offer opportunities to trade derivatives. It is this process that keeps the system dynamic and raises the level of cryptocurrency “consciousness.” However, at the same time, derivative agreements remain quite complex and it is recommended to use them with caution.
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