Financial Derivatives in the Cryptocurrency World
For those interested in the world of finance, financial derivatives are a huge part of how stock brokers and companies are able to turn such large profits. Surprisingly, these same financial derivatives are available in the cryptocurrency world, and have been for quite a few years. However, until recently, the fancier options were only available to large firms and professional traders. But thanks to the DEFI movement, the average cryptocurrency enthusiast can now try their hand at making money using financial derivatives.
What is a Financial Derivative?
In the finance world, there are three types of derivatives, and they are; swaps, futures, and options. They’re called derivatives because they derive their value from a financial contract which is dependent on another asset for its value. These derivatives, in general, function the same in the cryptocurrency world as they do in the fiat world.
A swap is an agreement where the money or currency involved will switch hands at a later date, often with interest payments involved. Futures on the other hand, are an agreement of obligation for a buyer to buy (or seller to sell) a specified asset at a specified price on a later date. Options are basically the same as futures, without the obligation to perform the action on the specified date. Financial derivatives are high level financial products which require a lot of knowledge. They are used to diffuse some of the higher risk scenarios which traders find themselves in, especially when it comes to the rocky world of cryptocurrency.
Financial Derivatives in Cryptocurrency
Surprisingly, swaps, futures, and options are all available in the cryptocurrency world. But often times the currencies for which they are available are limited to only the larger and more popular currencies such as Bitcoin and Ethereum. Financial derivatives are generally unregulated in the cryptocurrency world, thus making them much riskier than engaging in them in the fiat finance world. As the space develops, there are numerous securities which are registered with the SEC (Securities and Exchanges Commission) and do follow the regulations, however this is only a very small portion of the cryptocurrency derivatives market, and thus it’s imperative you do your research before diving in to any of these financial products.
The most common financial product talked about in the cryptocurrency world is futures, and you will often hear of people “shorting” or “going long” on the currency. Either of these tactics is an individual making a bet against another individual (or a marketplace) as to where the market price of a specified currency will be going. If Bitcoin is currently valued at $19,000 per coin and person A thinks the price is going to fall during the week, he will agree to sell person B one Bitcoin at $19,000 the next week. Person B takes this future because they believe the price will rise. As the week passes, and the price climbs to $21,000, Person A will have to sell their Bitcoin for $19,000 and thus “lose” the bet to Person B who will acquire this Bitcoin at a discount from market price. If the market goes the other way, and the value of Bitcoin goes to $17,000, Person A will “win” because he will sell the Bitcoin to person B for $2,000 above value. In this example, Person A is “shorting” the market, and Person B is “going long.”
This is not the only way to short bitcoin. There are a number of other options such as margin trading, binary options trading, prediction markets, and short-selling Bitcoin assets. Each of these is a slightly different process which carries varied levels of risk, so as mentioned above, do not engage in any of these high-risk trades unless you are well educated about the possible risks.
Where Can I Engage?
Prior to the DEFI movement, cryptocurrency financial derivatives were only available on a couple exchanges (CME and LedgerX) to registered or accredited investors. Now, there are a number of exchanges where anyone with an account can become involved. BitMex, OKEX, Cryptofacilities, Deribit, and BaseFEX, are five of the biggest marketplaces which offer Bitcoin derivative products to varying degrees. Due to tightening KYC and AML laws in the United States, all of the above five marketplaces do require basic identification to create an account. And they do monitor user activity for signs of illegal activity.
After you’ve been verified, no matter what marketplace you choose, you will need to fund your account with either cryptocurrency you already own, or you will need to buy some from the marketplace. Next, search whichever marketplace you have chosen for their “trading” or “futures” section. OKEX is a great marketplace for beginners as when you go to explore their futures trading options, they have both a beginner (called basic) and advanced version. Once you’ve made it here (and agreed to the risk involved with this type of trading) you’re ready to go! Yes, trading cryptocurrency financial derivatives is that easy!
It’s also important to note, that there are other exchanges which offer financial derivatives out there. But often times, these lesser known, or smaller, exchanges are associated with hacks and scams, so this is one of the few times when sticking with a bigger and more well-known exchange is probably safer.
Is There A Future for Bitcoin Futures?
Although it is very easy to set up a trading account on a website, Bitcoin and other cryptocurrency trading futures currently aren’t very popular and only hold a small portion of the cryptocurrency market. This is probably because a number of people feel that it is risky enough just to purchase Bitcoin, much less involve it in high risks trades!
This doesn’t mean it won’t grow though. Widespread cryptocurrency financial derivatives weren’t accessible until 2017, and even then, there were often too many hoops for the regular old Joe to jump through. But now in 2020, with 2021 on the horizon, a number of these products are available for an investor at any level at any size investment they wish. In fact, it’s likely that we are just at the dawn of cryptocurrency derivatives and that they will soon be the next big thing. And who knows, maybe you’ll be great at predicting the market.
