Crypto Derivatives In 2023 - Why Are They Better Than Spot Trading?
Even as global crypto markets have been in the doldrums for over a year, a sea of change is taking place in the market and the broader ecosystem.
This includes the entry of mainstream institutions and fintech startups into this space, making it possible to trade crypto anytime and anywhere with services like SoFi invest, followed by the development of a versatile derivatives market for cryptocurrencies.
Derivatives are essentially financial contracts that derive their value based on the price of the underlying asset, which can be stocks, bonds, commodities, indices, currencies, and more, hence the name, derivatives.
The same concept applies to cryptocurrencies, with investors and traders able to buy futures and options contracts based on a digital asset, with a set expiry date, for a variety of different purposes.
Different Derivatives Contracts & How They Work?
Before we dig in, here is a brief explainer of futures and options contracts, the two most popular types of derivatives contracts.
Futures contracts are essentially an agreement between two parties to either buy or sell an underlying asset, at a fixed price, and on a future date.
The value of the contract varies depending on the price of the underlying asset, with the potential to result in either a profit or loss to the parties involved.
Options contracts are a financial instrument which unlike futures don’t create any obligations for the buyer of the contract to buy or sell the underlying asset on a particular date.
There are two types of options contracts, to start with, the call option provides the holder of the contract the right but not the obligation to buy the underlying asset within a specified time period. Whereas, a put option provides the holder with the right to sell the underlying at a specified price, and within the specified period of time.
Why Are Crypto Derivatives Better Than Spot Trading?
Derivatives add substantial value to financial markets, from naked speculation, to hedging, diversification, and leverage, they remain largely indispensable for the effective functioning of markets.
While they come with their own share of risks, drawbacks, and issues, on the whole, the development of a robust derivatives market for cryptocurrency markets represent a step in the right direction, one that makes way for institutional capital and trading activity in the months ahead.
Beyond this, here are some reasons why crypto derivatives are better than spot trading for investors and traders alike.
Both futures and options provide investors with high levels of leverage, magnifying gains with even small moves in the price of the underlying asset. As always, leverage is a double-edged sword, and while it can magnify gains, it can just as easily wipe out the entire investment. As a result, this is suited for experienced traders, with a better understanding of market conditions.
Given the outsized gains that are possible with options and futures contracts, investors can make use of them to hedge against risks faced by their existing positions.In increasingly volatile cryptocurrency markets, hedging is absolutely essential to protect investments against unforeseen events.
Apart from speculating and hedging on the price of an underlying asset, traders can generate an income by selling or writing derivatives contracts, and earning the premiums resulting from the same.
This is akin to an insurance company selling policies to cover an eventuality, in return for a premium. If such an event fails to materialize, the entire premium is pocketed by the insurance company.
Global crypto markets are at an inflexion point, with plenty of changes, upheavals and transformations, but in the end, we expect this market to continue getting more efficient, and becoming on-par with traditional financial markets when it comes to depth, liquidity, and volatility.
The rise of derivatives and derivatives exchanges are a step in this direction, that stands to overhaul the crypto markets as we know it.
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