Crypto derivative: concept

A crypto derivative is a derivative in which the underlying is a cryptocurrency such as Bitcoin and Ethereum. A crypto derivative contract is an agreement to buy or sell a cryptocurrency (or broadly a crypto asset) at a specific time in the future, either via physical or cash settlement. Bitcoin (abbreviation: BTC ) (as a coin) is the currency a decentralized peer-to-peer cryptocurrency that is supported by its users with no central authority or middlemen. Ethereum is a decentralized blockchain with smart contract functionality. Bitcoin, the first of its kind cryptocurrency is maintained by a proof of work (PoW) blockchain. Ether (abbreviation: ETH) is the native cryptocurrency of the platform.

Cryptocurrencies are digital assets. Unlike fiat currencies, cryptocurrencies are powered by peer-to-peer networks rather than issued and backed by central banks. Crypto derivatives are traded by market participants either over the counter (OTC) or via crypto exchanges.

Main examples

The main examples of crypto derivatives are crypto futures contracts, crypto options and perpetual swaps. A crypto futures contract is a futures contract established between two market participants who take direction or bet on a cryptocurrency’s future price, granting them exposure to cryptocurrencies either with direct holdings or without purchasing them. Crypto futures are standard futures contracts, i.e., they have certain features defined by exchanges and portals where they trade. Traditionally, a futures contract is physically settled, where one party must deliver the underlying asset, while the other takes delivery. As digital assets, cryptocurrencies are settled monetarily. However, with the use of perpetual futures contracts, an expiration date is not a requirement for settlement.

A crypto option is a financial contract (an option) that gives the trader the right—but not the obligation—to buy or sell an underlying cryptocurrency at a predetermined price, known as the “strike price,” within a specific time interval. Options can either be call options (that give the holder the right to buy the underlying asset at the strike price) or
put options (which allow the holder to sell the underlying asset at the strike price). The premium paid for an option can be much lower than the price in the outright purchase of the cryptocurrency, allowing traders to gain exposure with minimum capital at risk.

A perpetual swap is a type of swap that traders use to take position on the future price movements of cryptocurrencies. Unlike a typical futures contract, perpetual swaps do not have expiration dates, a feature that eliminates the need to constantly re-enter into a long or short position. The price of perpetual contracts is considered in establishing the spot prices of their underlying assets.