What are crypto derivatives? It’s a question that’s popping up more and more as cryptocurrency becomes mainstream. Maybe you’ve heard the term tossed around in crypto forums or seen it in the news. Or perhaps you’re a curious investor looking for new ways to trade. Whatever brought you here, you’re in the right place.
In this guide, we’ll cover:
- The basics: What exactly are crypto derivatives?
- Types of crypto derivatives: Futures, options, and more
- Pros and cons
- How to trade crypto derivatives: A step-by-step guide for beginners
- Where to trade: Top 3 exchanges for crypto derivatives
Let’s start!
What Is Crypto Derivatives?
A derivative is a financial product whose value comes from something else. This “something else” is called the underlying asset. In the world of crypto, these underlying assets are cryptocurrencies like Bitcoin or Ethereum.
Now, you might be wondering, “Why not just buy the cryptocurrency itself?” Well, derivatives offer some unique advantages. They allow you to make bets on the price of a cryptocurrency without actually owning it. This can be useful in many situations.
For example, let’s say you think the price of Bitcoin will go up, but you don’t want to buy and store actual Bitcoin. With a Bitcoin derivative, you can still potentially profit from the price increase without dealing with digital wallets or storage concerns.
To make this clearer, let me give you a real-world example. Imagine you’re a farmer (bear with me, this will make sense soon). You grow apples, and it’s currently spring. You’re worried that the price of apples might drop by harvest time in the fall. To protect yourself, you might sign a contract with a buyer now, agreeing to sell your apples at today’s price when they’re ready in the fall. This contract is a type of derivative – its value is based on (or “derived from”) the price of apples.
In the crypto world, it works similarly. Let’s say Bitcoin is trading at $50,000 today. You could enter into a futures contract (a type of derivative) to buy one Bitcoin three months from now at $52,000. If the price of Bitcoin goes up to $60,000 in three months, you’ve made a profit because you can buy it for $52,000 and immediately sell it for $60,000. If it goes down to $45,000, you’ve made a loss.
Crypto Derivatives vs Spot Trading
The key difference between crypto derivatives and simply buying cryptocurrencies (known as “spot trading”) is that with derivatives, you’re not actually owning the cryptocurrency. You’re just making an agreement about its future price.
It’s important to note that while derivatives can offer opportunities for profit, they also come with risks. They often involve borrowing money (called leverage) to make bigger bets, which can lead to bigger losses if things don’t go as planned.
In the next section, we’ll discuss the different types of crypto derivatives available.
Types of Crypto Derivatives
Now that we understand what crypto derivatives are, let’s take a look at the different types you might come across. There are four main types of crypto derivatives: futures, options, perpetual swaps, and forwards. Don’t worry if these sound complicated – I’ll break them down for you in simple terms.
1. Futures
Futures are perhaps the most common type of crypto derivative. When you trade futures, you’re agreeing to buy or sell a specific amount of cryptocurrency at a set price on a future date. It’s like making a promise about a trade you’ll make later.
For example, let’s say Bitcoin is trading at $50,000 today. You might enter a futures contract to buy one Bitcoin three months from now at $52,000. If you think the price will go up, this could be a good deal.
2. Options
Options are a bit different. They give you the right, but not the obligation, to buy or sell cryptocurrency at a specific price before a certain date. It’s like having a coupon that you can choose to use or not.
There are two types of options:
- Call options: These give you the right to buy crypto at a set price.
- Put options: These give you the right to sell crypto at a set price.
For instance, you might buy a call option that gives you the right to purchase one Bitcoin at $55,000 anytime in the next month. If Bitcoin’s price goes above $55,000, you can use your option to buy it at the lower price and potentially make a profit.
3. Perpetual Swaps
Perpetual swaps are a bit more complex, but they’re very popular in crypto trading. Unlike futures, they don’t have an expiry date – you can hold the position as long as you want (or until you’re forced to close it).
The price of perpetual swaps is kept close to the actual cryptocurrency price through a mechanism called funding rates. Sometimes you might receive payments, and other times you might have to pay, depending on market conditions.
4. Forwards
Forwards are similar to futures, but they’re customized agreements between two parties, rather than standardized contracts traded on an exchange. They’re less common for everyday traders and are mostly used by large institutions or wealthy individuals.
Pros and Cons of Crypto Derivatives
Now that we’ve covered the types, let’s talk about the good and not-so-good aspects of trading crypto derivatives.
Pros:
1. Leverage: Derivatives often allow you to trade with more money than you actually have. This is called leverage, and it can amplify your profits. For example, with 10x leverage, a 1% price move could result in a 10% profit (or loss).
2. Hedging: If you own cryptocurrencies, you can use derivatives to protect against potential price drops. It’s like buying insurance for your crypto investments.
3. Profit from price drops: With derivatives, you can potentially make money even when crypto prices are falling. This is called “short selling.”
4. No need for a crypto wallet: You don’t need to worry about securely storing actual cryptocurrencies when trading derivatives.
Cons:
1. High risk: The leverage that can increase your profits can also magnify your losses. You could potentially lose more than your initial investment.
2. Complexity: Derivatives can be complicated, especially for beginners. It’s easy to make mistakes if you don’t fully understand what you’re doing.
3. Fees: Trading derivatives often involves various fees that can eat into your profits.
4. Volatility: The crypto market is already volatile, and derivatives can be even more so. Prices can change rapidly, leading to unexpected losses.
5. Regulatory uncertainty: The rules around crypto derivatives are still evolving in many countries, which could affect your ability to trade in the future.
In the next section, we’ll walk through how to actually trade these derivatives, step by step.
How to Trade Crypto Derivatives: Step-by-Step Guide
Now that we understand what crypto derivatives are and their types, let’s walk through how to actually trade them. Remember, this is a complex topic, so take your time to understand each step before you start trading with real money.
1. Choose a reliable exchange:
First, you need to pick a trustworthy platform to trade on. We’ll discuss the top 3 platforms in the next section, but for now, let’s assume you’ve chosen one.
2. Create an account and verify your identity:
Sign up on the exchange website. You’ll need to provide some personal information and usually upload a government-issued ID. This process is called KYC (Know Your Customer) and is required by most reputable exchanges.
3. Fund your account:
Once verified, you can deposit money into your account. Most exchanges accept bank transfers or credit card payments. Some also allow you to deposit cryptocurrencies.
4. Familiarize yourself with the trading interface:
Take some time to explore the platform. Look for the ‘Derivatives’ or ‘Futures’ section. Don’t worry if it seems overwhelming at first – we all start somewhere!
5. Choose your contract:
Decide which cryptocurrency you want to trade derivatives for. Bitcoin and Ethereum are popular choices for beginners due to their higher liquidity.
6. Decide on your position:
You’ll need to choose whether you think the price will go up (long) or down (short). If you think Bitcoin will rise, you’d open a long position.
7. Set your leverage:
Be very careful here. Leverage multiplies your potential profits, but also your potential losses. As a beginner, it’s wise to use low leverage or no leverage at all.
8. Place your order:
Enter the amount you want to trade and double-check all details before confirming. You can usually choose between a market order (executed immediately at current price) or a limit order (executed when the price reaches a level you specify).
9. Monitor your position:
Keep an eye on your trade. You might want to set stop-loss orders to limit potential losses.
10. Close your position:
When you’re ready to end your trade, close your position. Your profit or loss will be realized at this point.
Remember, practice makes perfect. Many exchanges offer demo accounts where you can trade with fake money to get a feel for the process.
Best Crypto Derivatives Exchanges for Beginners
Now, let’s look at three popular exchanges that offer crypto derivatives trading. Each has its strengths and weaknesses, so consider what’s most important to you.
1. Binance
Binance is one of the largest crypto exchanges in the world. Here’s what you need to know:
Pros:
- Wide range of cryptocurrencies and derivative products
- Generally low fees
- High liquidity, which means you can usually buy or sell quickly
- Offers a comprehensive learning section for beginners
Cons:
- The platform can be overwhelming due to its many features
- Not available in some countries, including the United States
2. Bybit
Bybit is known for its user-friendly interface and is popular among derivatives traders.
Pros:
- Clean, easy-to-use interface that’s great for beginners
- Offers high leverage (but remember, high leverage means high risk!)
- Provides a demo account for practice trading
Cons:
- Limited payment options for depositing funds
3. OKX
OKX (formerly OKEx) offers a wide range of crypto products, including derivatives.
Pros:
- Offers a variety of derivative products
- Provides educational resources for new traders
- Has a mobile app for trading on the go
Cons:
- Customer support can be slow at times
When choosing an exchange, consider factors like:
- Available cryptocurrencies and derivative products
- Fees (trading fees, withdrawal fees, etc.)
- User interface and ease of use
- Security features
- Customer support quality
- Availability in your country
In the next section, we’ll discuss some important things to keep in mind as you start your journey into crypto derivatives trading.
Important Considerations for Beginners
As you start your journey into crypto derivatives trading, there are several key points you should always keep in mind:
1. Risk Management:
This is very important. Never invest more than you can afford to lose. I always recommend starting with small amounts to get a feel for the market. Set stop-loss orders to limit potential losses, and don’t be tempted to over-leverage your positions.
2. Education is Key:
The crypto market moves fast, and there’s always something new to learn. Make it a habit to stay informed about market trends, new regulations, and trading strategies. Many exchanges offer free educational resources – take advantage of these!
3. Start Small:
When you’re ready to trade with real money, begin with small positions. This allows you to gain experience without risking too much. As you become more comfortable and knowledgeable, you can gradually increase your position sizes.
4. Understand Fees:
Each trade comes with fees, and these can add up quickly, especially if you’re trading frequently. Make sure you understand the fee structure of your chosen exchange. Some fees to watch out for include trading fees, funding fees (for perpetual swaps), and withdrawal fees.
5. Use Demo Accounts:
Many exchanges offer demo accounts where you can trade with fake money. These are excellent tools for getting familiar with the trading interface and testing strategies without any financial risk.
6. Be Wary of FOMO:
Fear Of Missing Out (FOMO) can lead to hasty, emotional decisions. Remember, there will always be new opportunities in the market. It’s better to miss out on a trade than to enter one you don’t fully understand.
Regulatory Landscape of Crypto Derivatives
The regulation of crypto derivatives varies significantly from country to country. Here’s a brief overview of the current situation in Australia, the UK, and India:
Australia
In Australia, crypto derivatives are regulated by the Australian Securities and Investments Commission (ASIC). As of 2021, ASIC has implemented stricter rules for the sale of crypto derivatives to retail investors. These rules aim to protect consumers by ensuring they understand the risks involved.
United Kingdom
The UK’s Financial Conduct Authority (FCA) has taken a firm stance on crypto derivatives. Since January 2020, the sale of crypto derivatives to retail consumers has been banned in the UK. The FCA cited the extreme volatility of cryptocurrencies and the difficulty for consumers to reliably value these products as reasons for the ban.
India
The regulatory landscape for crypto derivatives in India is still evolving. As of 2021, there’s no specific regulation for crypto derivatives. However, the Indian government has been working on a cryptocurrency bill that could provide more clarity on the legal status of these financial products.
Remember, regulations can change quickly in the crypto world. Always check the most current rules in your country before trading.
Conclusion
As we wrap up this guide, I want to emphasize the importance of responsible trading. Crypto derivatives can offer exciting opportunities, but they also come with significant risks. Always do your own research, start small, and never invest more than you can afford to lose. With careful study and practice, you can develop the skills to navigate this complex but potentially rewarding market. Stay informed, stay cautious, and may your trading journey be a successful one!
FAQs
- What are crypto derivatives?
Crypto derivatives are financial contracts whose value is based on underlying cryptocurrency assets. They allow traders to speculate on crypto prices without owning the actual cryptocurrencies, offering opportunities for hedging and leveraged trading.
- Are crypto derivatives legal in the UK?
The UK’s FCA banned the sale of crypto derivatives to retail consumers in October 2020. This ban includes products like crypto ETNs (Exchange Traded Notes).
- Can I trade crypto derivatives in Australia?
Yes, you can trade crypto derivatives in Australia, including Contracts for Difference (CFDs).
- Are all crypto exchanges allowed to offer derivatives trading in Australia?
No. For example, the ASIC cancelled Binance Australia’s derivatives license. Always verify if an exchange is properly licensed before trading.
- What’s the difference between spot trading and derivatives trading in crypto?
Spot trading involves buying and selling actual cryptocurrencies. Derivatives trading involves contracts based on the price of cryptocurrencies, without owning the actual crypto assets.