What Are Crypto Derivatives? (Perpetual, Futures Contract Explained)

What are crypto derivatives? The word derivative implies that it is derived from something. Crypto derivatives, therefore, derive their value from cryptocurrencies. They exist as financial contracts that two parties enter into to speculate on the underlying cryptocurrency’s price on a future date.
Let’s dive into derivatives and learn what exactly is perpetual and futures contract!

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Links Mentioned:
Explore crypto exchanges – https://www.coingecko.com/en/exchanges

Timestamps:
0:00 – Intro
0:27 – What are crypto derivatives?
1:52 – What are futures?
3:59 – What are perpetual contracts?
5:06 – Leverage opportunities
7:15 – Closing thoughts

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#Derivatives #Perpetual #Futures #Options #Swaps #crypto #DeFi

Did you know that there are ways to  invest in Bitcoin without holding   actual Bitcoin? This is made possible through  financial instruments like derivatives. So what are crypto derivatives? Well, that is  what we are going to find out shortly including   some of the types of crypto derivatives  like Futures and perpetual contracts.

Make sure to stick around to find out  how they work and how they differ through   simple explanations and practical  examples. Let’s get to it.  So, what are crypto derivatives? Ok, the word derivative implies that  it is derived from something, right?  

In financial terms, derivatives are instruments  that derive their value from an underlying asset. Crypto derivatives therefore derive their  value from cryptocurrencies.They exist as   financial contracts that two parties enter into   to speculate on the underlying  cryptocurrency’s price on a future date. So for example, a Futures contract,  which is a type of crypto derivative,  

Will have the parties agree on a selling  and buying price of the cryptocurrency   in say one month, regardless of  what the actual price will be. Fast forward to a month later, the buyer  may profit if the price of the underlying  

Cryptocurrency went up and is now higher  than the agreed price in the contract. And if the price of the underlying cryptocurrency   goes down and lies below the agreed  price, the seller will make a profit   because the buyer will be purchasing the asset  at a higher price than the actual market price.

Don’t worry, we’ll look at actual examples  shortly when we take a closer look at the   types of crypto derivatives. Some of  these types include options, swaps,   Futures and perpetual contracts. Though for this  video, we’re going to focus on the last two. These derivatives generally differ  depending on the conditions in  

The contract as you’ll see shortly. Let’s start with Futures, what is it?  As the name suggests, it is a  legal agreement between two parties   to buy or sell an asset at  a set price in the future. So before the parties get into the contract  they generally agree on two things.  

One is the price at which they will exchange the  asset in future and two is the expiration date   of the contract which is simply the date  the contract will be closed and settled. Ok let’s now find out how crypto  Futures work through a practical example Say we have two crypto derivative traders,  

Mercy and Frank who enter into a futures  contract when the price of Bitcoin is $30,000. Mercy is bullish on Bitcoin and she is confident  that it will surpass $30,000 in a month which is   the expiration date of the contract. This  means that she will have to pay the $30,000  

For 1BTC regardless of BTC’s price in a month. Frank on the other hand is bearish on BTC and  has his reasons to believe that the price of BTC   will drop below $30,000 in the coming month.  So the contract from Frank’s perspective,  

Commits him to selling BTC at the agreed price,  regardless of the asset’s price in a month. Alright, let’s look at different scenarios  that’ll determine which of the two makes a profit. Scenario 1 It could be that Mercy  

Was right and the price of Bitcoin does go up to  say, $37,000. So now she’ll actually be purchasing   BTC from Frank at a discount. In this case, she’ll  make a profit of $7,000 without factoring in fees. Scenario 2 Let’s assume Mercy’s prediction was wrong  

And the price of BTC went down and is now trading  at $25,000. She’ll still have to buy the BTC from   Frank at the agreed $30000 meaning she makes  a $5000 loss while Frank makes a $5000 profit. There’s still some nuances to Futures but that is   generally how it works. What about Perpetual Contracts?

Perpetual contracts are more or less   similar to futures but with a distinct  difference, they have no expiration date. So investors can hold their positions however long  they like. For this reason, perpetual contracts   have price pegs to ensure that they are traded  at prices that are equal or almost equal to the  

Spot market prices. This price peg is maintained  through a premium called a funding payment that   is paid between the contract sellers and buyers to  help keep the price in line with the spot market. Let’s find out how Perpetual contracts work. Say that Mercy decides to invest  in perpetual contracts this time  

When the price of Bitcoin is around  $30,000. Since she predicts that the   price of Bitcoin may go up, she decides to  purchase a perpetual contract at $30,000. After two months, the price of  Bitcoin does indeed go up to  

Around $40,000. So Mercy, who is happy with the  $10,000 profit, decides to close her position. Another thing about crypto derivatives  like Futures and perpetual contracts,   is that they offer leverage opportunities.  This simply means that it allows you to   open a trading position that is  bigger than your trading capital.

So in Mercy’s case, if a derivative  exchange offers 2x leverage,   it means that her capital will  now double and so will her profit. However, just as leverage amplifies profits, it  also amplifies losses so there is a very high   risk of being liquidated. Let’s quickly  see how this may happen in Mercy’s case.

But before that, let’s try to break  down the following concepts first,   that is the initial margin and the maintenance  margin. The former describes the minimum value   that needs to be paid to open a leveraged  position. For illustration purposes,   let’s set this value at $30,000. Meaning  Mercy pays an initial margin of $30,000,  

Which will act as her collateral.  to open a 2x leveraged position. The maintenance margin, on the other hand, is  the minimum amount of collateral Mercy must hold   to keep her trading positions open. If Bitcoin’s  prices move against Mercy and her margin balance  

Drops below this level, she may be asked to  add more funds to her account or be liquidated. That said, perpetuals are by far the most   traded financial instruments in crypto.  At the time of making this video,   the 24 hour volume of perpetuals was over  $126 billion compared to Futures’ $5billion.

Though, you might still wonder,   why not just hold actual Bitcoin if  the price is pegged to it anyway? Well, these derivatives have an important  function in crypto of managing risks. Say Mercy holds actual Bitcoin but its price  is going down. Since she is also a crypto  

Derivatives trader, she can decide to purchase  a derivative contract whose value swings in the   opposite direction of the BTC she holds. Ideally,  now she’ll be able to offset the losses of her   actual BTC with the gains from the derivatives. All in all, this collaboration between crypto  

And traditional financial instruments is a major  step forward for digital assets in general. Also,   it gives investors an option to be involved with  digital assets without necessarily holding them. So, are you going to experiment with crypto  derivatives or are you gonna stick with the good  

Old Holding On for Dear Life tactic? We’d love to  hear your thoughts so let us know in the comments.  Remember to like, subscribe and follow us  on all our socials for future alpha! See ya!