What are derivative products? How do they apply to the cryptocurrency market?
In the world of trading, derivatives allow you to instantly reap the rewards of your ideas and analysis.
Without them, finance would most likely have remained a place where only people who have a certain amount of money can make more money. Derivatives have not only allowed smaller amounts of capital to access financial markets but, they accelerated the entire investment process. Today I will introduce you to how derivatives apply to the cryptocurrency market.
Derivative products: definition
A derivative, as the name suggests, is a financial security that is directly dependent on an underlying asset or other assets (indexes, indices, commodities, cryptocurrencies, etc.). This direct dependence between the instrument and the asset means that derivatives are often referred to by the name of the security they represent.
Derivatives often consist of futures contracts that are entered into between the buyer and seller at the time of investment. They relate to variations in the price of the underlying asset over a given unit of time.
What you are investing in is therefore not the possession of a financial security (it is not a question of buying or selling shares of a company in the traditional sense) but the fulfillment of the terms of the contract.
What are derivative products used for?
Derivatives are instruments that primarily serve to reduce market entry requirements. Not only are the requirements reduced in terms of minimum capital but also and above all in terms of time. If previously, to start investing you needed hundreds of thousands of euros, with derivatives you can exploit the leverage effect. This is an instrument that allows you to commit a much smaller amount of money than stipulated in the contract.
In Europe for example, leverage has a legal maximum of 1:30. This means that you can commit capital equivalent to 1/30 of the investment threshold indicated by the derivative product. If you want to invest in an asset listed at €1800, with a leverage of 1:30, you can invest there with 60 euros. Without leverage, the investment would not have been possible if the amount corresponding to the full price of Amazon shares had not been committed.
On the other hand, in terms of time, derivative products eliminate the bureaucracy associated with direct purchasing. The latter can cause delays of several days or even weeks. In this way, it is possible to carry out an efficient and profitable intraday operation.
Application of derivative products to the cryptocurrency market
Unlike spot contracts, where you can make money on the rise of the stock market simply by purchasing crypto assets, derivatives allow you to make money on both the rise and fall.
By selling your cryptocurrency on the spot market, you are simply exchanging it for dollars while maintaining its value.
However, if you sell it short on derivatives markets, you make money on every point it falls. As you can see, you don't even need to trade real cryptocurrencies when investing in derivatives. With the advent of derivatives, opportunities have opened up for large investors to short sell cryptocurrencies and make money.
The advantages of derivative products in the cryptocurrency market
First of all, derivatives allow you to hedge price risks without using the actual asset. Additionally, those who do not own real cryptocurrencies can trade them and make money through derivatives. Opening trades are part of the total trading volume and increase market liquidity. The greater the liquidity, the lower the volatility. Also, as the number of traders increases, the power of confrontation between buyers and sellers contributes to the reduction of the spread.
Derivatives are a major way for institutional investors to enter the market, with a wide range of instruments for managing cryptocurrency assets. Through cryptocurrency futures and options, it is possible to hedge more risk, which is why investors have entered the market.
What derivative products for cryptocurrencies?
The most well-known derivatives or futures are CFDs, futures, options and certificates. All of these financial instruments can be used to invest indirectly in cryptocurrencies. This means that you do not buy the cryptocurrency itself, but only bet on its performance which can be positive or negative.
CFD
CFD stands for Contracts for Difference. Speculators therefore enter into a contract on the difference in price of the underlying asset. CFDs can be leveraged or short sold. Leverage increases the chances of making higher profits, but losses can also be greater. A commission is charged when opening and closing a contract.
Futures
Futures are nothing more than futures contracts. Buyers and sellers agree to exchange the digital currency at a certain price and on a fixed date in the future. Investors can thus protect themselves from the risks linked to price fluctuations.
Options
Options are financial contracts that give investors the right to buy or sell a cryptocurrency at a specific time and price. Neither the purchase nor the sale of an underlying asset is obligatory, speculators simply have the right to do so.
Certificates
Investment certificates are securities whose value depends on the evolution of the price of their underlying asset. Investors can bet on all kinds of market developments: rise, fall or stagnation. Since there are many different requirements for certificates, I advise beginners to be especially careful in this area.
Our final word on derivative products
Derivatives came into the market to facilitate transactions and allow low capital investments to invest in financial markets. In the world of cryptocurrency, derivative products are therefore a boon for those who cannot hold cryptos due to their high price. However, I must remind you that trading involves risks and you should be aware of this.
To go further and discover platforms for trading derivative products
- Our opinion on PrimeXBT: The ideal platform for leveraged trading?
- ByBit platform review: How to use the platform?
- Etoro: Everything you need to know about copy trading
Disclaimer: This is not investment advice. This is general information. Do your personal research before investing. Always.
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