Derivatives are tradable securities or contracts whose value is determined by an underlying asset. The underlying asset in bitcoin derivatives is always Bitcoin (BTC) or other leading cryptocurrencies.
Bitcoin Derivatives are complex, high-risk financial products that are beneficial for risk management through hedging.
1/ Traditional derivatives VS Bitcoin futures
While conventional markets have used derivatives in various ways for thousands of years, futures contracts were first established in the 1970s and 1980s by the Chicago Mercantile Exchange and the Chicago Board of Trade.
Futures, forwards, and options are the most prevalent derivatives, and they are based on a range of assets such as stocks, currencies, bonds, and commodities. The market’s size is difficult to determine due to the vast amount of derivatives available today, with estimates varying from trillions to over a quadrillion dollars.
Bitcoin Derivatives’s future
Bitcoin futures were the first crypto derivatives to go popular, and they continue to be the most traded in terms of volume. BTC futures were first traded on smaller platforms in 2012, but it wasn’t until 2014 that big exchanges, such as CME Group Inc and Cboe Global Markets Inc, decided to follow suit. Bitcoin futures are already one of the most widely traded securities in the industry.
2/ Bitcoin Derivatives future contract
What is Bitcoin futures contract?
A futures contract is an agreement between two parties — in this example, two users on an exchange — to purchase and sell an underlying asset (BTC) at a predetermined price (the forward price) at a future date.
While the specific terms of futures contracts may differ from exchange to exchange, the core principle remains the same: two parties agree to lock in the price of an underlying asset for a future transaction.
Most exchanges support cash settlements instead of requiring futures contract holders to receive the actual underlying asset (such as barrels of oil or gold bars) once the contract expires.
Physically-settled Bitcoin futures, such as those provided by Intercontinental Exchange’s Bakkt, are gaining appeal, as actual Bitcoins can be moved more easily than other commodities.
How does a Bitcoin futures contract work?
To begin, the weekly futures market simply means that the contract holder is betting on the price of Bitcoin over the duration of one week; OKEx also offers futures with bi-weekly, quarterly, and bi-quarterly time frames.
So, if Bitcoin is now trading at $10,000 and Adam believes the price will climb next week, he might open a long position on OKEx’s weekly futures market with a minimum of one contract (each contract represents $100 in BTC).
When someone buys Bitcoin and retains it (goes long), they expect the price to rise, but they will lose money if the price falls. Robbie agrees to sell 100 contracts, or 1 BTC, for the agreed-upon price of $10,000 on the settlement day next week.
The exchange matches Adam and Robbie and they engage into a futures contract in which Adam promises to purchase 1 BTC for $10,000 and Robbie commits to selling 1 BTC for $10,000 when the contract expires.
The price of bitcoin on the settlement day, one week later, will determine whether these two traders make money or lose money.
After a week, Bitcoin is worth $15,000 on the market.
Bitcoin Derivatives options
Unlike traditional futures, when two parties agree on a date and price to buy or sell the underlying asset, you acquire the “option” or right to buy or sell the asset at a specified price in the future using options. Despite the fact that crypto options are newer than futures, Bitcoin options reached an all-time high of nearly $1 billion in Open Interest this month (OI).
Puts and calls: Call options and put options are the two forms of option contracts. The holder of a call option has the right to acquire an underlying asset at a specific date (expiry), whereas the holder of a put option has the right to sell it. An American option can be exercised (that is, bought or sold) at any time prior to the expiration date, but a European option can only be exercised on the expiration day.
3/ Why do users use futures contracts to acquire and sell Bitcoin Derivatives?
Why would someone purchase or sell Bitcoin using a futures contract rather than directly on the spot market? Risk management and conjecture are the two most common responses.
Farmers have historically utilized future contracts to limit risk and manage cash flow by guaranteeing that they can acquire commitments for their goods ahead of time and at a pre-determined price. Given the time it takes to prepare agricultural goods, it’s understandable that farmers would like to avoid future market price changes and uncertainty.
Volatility and price swings in Bitcoin need careful risk management, particularly for people who rely on digital assets for a regular source of income such as Bitcoin miners.
Traders and speculators require the capacity to bet both long and short in order to profit from market volatility in either direction (up or down).
Futures contracts allow pessimists a way to influence market sentiment, a phenomenon that the Federal Reserve Bank of San Francisco explored in depth in their report titled How Futures Trading Changed Bitcoin Prices.
Finally, Bitcoin futures are popular because they allow traders to employ leverage, allowing them to establish positions that are greater than their initial deposits as long as they maintain an acceptable margin ratio set by the exchange.
4/ Bitcoin Derivatives swaps or perpetual futures
A separate technique used by perpetual futures, or swaps, to impose price convergence at regular intervals which the funding rate
The funding rate’s goal is to keep a contract’s price in line with the underlying asset’s spot price, avoiding large price swings.
The financing rate that is exchanged between the two parties to a contract (the long and short parties) rather than a charge that is collected by the exchange.
Why would shorts (those on the selling side) leave a perpetual contract open indefinitely if the value of the contract continues rising?
5/ What are BTC perpetual swaps and how do they work?
If a perpetual swap contract is trading at $9,000 (the indicated price) but BTC is trading at $9,005, the financing rate will be negative (to account for the difference in price). A negative financing rate indicates that short-term investors must compensate long-term investors. If the contract price is greater than the spot price, however, the financing rate will be positive, since long contract holders must compensate short contract holders. The funding rate encourages the creation of new positions in each of these cases, which might push the contract’s price closer to the spot price. Most exchanges, including OKEx, provide funding rate payments every 8 hours as long as contract holders keep their positions open.
Do your own research, practice before risking real money. Never risk more than you can afford to lose with any financial instrument.