The most common basic assets from which derivatives are recognized are currencies, bonds and commodities. However, the value of derivatives is not only tied to the elements mentioned above, because derivatives can derive value from all existing assets.
Derivatives tend to be used for good or for bad. They can be used as speculative tools to ensure economic growth, and can also cripple the financial system.
By themselves, derivatives have no value. Their value is derived from the estimated price movements of the assets in play.
Types of Derivatives
Derivatives have four main forms, namely: options, forward, swaps, and futures.
These contracts allow the buyer or seller to make transactions with a specific asset at a predetermined price while working with a specific timeline. Traders are not mandated to buy assets according to contracts, which is the clear difference between options and futures contracts.
Forward is a contract that can be customized to suit the needs of the trader. This is usually done on an over-the-counter (OTC) exchange. Risk factors must also be considered.
A swap occurs between two parties who are united solely to make a profit by planning the exchange of cash flows at a specified time in the future. The assets that are usually exchanged are bonds, notes, or loans.
This contract requires the trader to buy or sell an asset at a predetermined date and price.
Use of Derivatives in Crypto Trading
As cryptocurrency’s fame continues to spread relentlessly, traders are constantly finding favorable price fluctuations and trying to make the most of them.
With the introduction of Bitcoin and altcoin futures, traders gained new tools they could use to reduce risk by simply signing contracts.
Traders see it as an opportunity to make a profit simply by identifying a cryptocurrency with a low price and buying it to sell it when its price goes up on Bityard . It is worth noting that this strategy is very risky, and if it must be used, it will only be played during an uptrend.
Traders have another strategy that is used to make profits which is called shorting. This is useful even when the market is trending down. This strategy involves borrowing assets from third parties such as brokers or exchanges and selling them when they believe their price will fall.
When the price finally drops, the trader buys the same amount of asset again, but this time at a lower price, and as the price fluctuates, they make a profit. In return, the broker or exchange receives a commission.
Spot Market vs Derivative Market
Even those who were lucky enough to sell before the significant drop and intend to buy back lower, need prices to bounce back. If not, then there’s no way to make a profit.
Another characteristic of the spot market is that they force traders to hold assets they wish to speculate on. Bitcoin derivatives, on the other hand, can allow people to trade contracts that follow Bitcoin’s price without actually owning any Bitcoin. Then what about the Bitcoin derivatives market?
How to Trade the Bitcoin Derivatives Market
This example is best illustrated with a physical asset. Imagine that you want to speculate on the price of oil. You can literally go and physically buy barrels of oil and sell it when the price goes up.
Of course, this is impractical and expensive because you also have to consider storage and transportation costs. A much better approach is to trade instruments or contracts whose prices are tied to the price of oil.
This contract is an agreement that you sign with the counterparty. Let’s go back to BTC and imagine you believe the price will go up while other people believe the price will go down.
You and the other speculator can sign an agreement stating that after a certain period of time, after the price has moved in any direction, one party will have to pay the difference in the price of the other.
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