What are Derivatives (and Crypto Derivatives)?

A derivative is a financial asset, whose value is derived from that of an underlying asset or a class of assets, and the price of a derivative is dependent on the price of the underlying asset. Common examples of underlying assets for derivatives in the traditional financial markets are stocks, bonds, commodities, indexes etc. 

It is a form of contract between two parties, where the buyer agrees to purchase an asset sold by the seller at an agreed upon price at a specified date (also known as the expiry or settlement date). 

In 2019, the market for derivatives rose to $640 trillion from $544 trillion in 2018, the highest level since 2014, according to the Bank of International Settlement. Similarly, the derivatives market for cryptocurrency is growing steadily, as adoption for cryptocurrency increases. 

According to cryptocurrency analytics firm TokenInsight in its 2019 Cryptocurrency Derivatives Exchange Industry Annual Report, total crypto derivatives trading on exchanges topped $3 trillion in 2019 with an average daily trading volume of about $8.5 billion. As the crypto industry continues to grow, it is expected that cryptocurrency derivatives will be increasingly popular, to the extent which it can rival the trading volumes of derivatives in the traditional financial markets. 

Now, what types of derivative products are there? The most common types of derivatives are forwards, futures, options and swaps, which are mainly traded Over The Counter (OTC), but also on exchanges. Investors often utilize these derivatives to hedge against risks or speculate on the future prices of an asset. 

Likewise, the cryptocurrency derivative market draws from a similar concept, to allow cryptocurrency traders and investors another avenue to insure against risks or gain profits. Currently, product choices are limited, with futures and perpetual contracts as the main drivers. However, with rising user adoption, it is only a matter of time before new products are introduced. Several exchanges have already begun launching cryptocurrency derivatives of their own, such as BiKi’s Perpetual Contract, and with recent announcements of Synthetix Exchange possibly offering binary options trading in the near future, who knows what might the future hold?      

Until then, perpetual future contracts remains one of the most popular cryptocurrency derivatives traded on the market today. For the uninitiated, a perpetual future contract is a special type of future contract, the fundamental difference being that perpetual future contracts do not have an expiry or settlement date. Moreover, perpetual contracts trade at a price close to the price of the underlying asset, while the price of futures may vary to a larger extent.   

Like all financial products, cryptocurrency derivatives carry risks, and users are encouraged to fully understand the products before engaging in trading derivatives. For a comprehensive guide on how to trade perpetual contracts, visit here.  

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