Cryptocurrency derivatives are tradeable financial contracts whose value is derived from the price of an underlying digital asset, such as Bitcoin, Ethereum, or other cryptocurrencies. These contracts allow traders to speculate on the future price movements of cryptocurrencies without actually owning the underlying assets.
Derivatives are widely used in traditional financial (TradFi) markets and have gained popularity in the crypto space as a way for traders to hedge risk, enhance returns, or gain exposure to crypto price movements. Types of crypto derivatives include futures, options, and perpetuals.
A futures contract is an agreement to buy or sell an asset (e.g., Bitcoin) at a predetermined price at a specific time in the future. Traders can go ‘long’ (betting the price will rise) or ‘short’ (betting the price will fall). Options give traders the right, but not the obligation, to buy (call option) or sell (put option) an asset at a specific price before or at a certain date.
Perpetual contracts are a special type of futures contract with no expiration date. Traders can hold their positions indefinitely, and the contract’s price is pegged closely to the spot market price through a funding rate mechanism (payments between long and short positions to balance supply and demand).
Representing fractional ownership of leveraged positions, leveraged tokens allow traders to gain exposure to a leveraged position (e.g., 2x, 3x) without the complexity of managing margin and liquidation risks. Meanwhile, swaps are agreements to exchange the returns on one cryptocurrency for another or to swap variable interest rates with fixed rates.
Note that cryptocurrencies are inherently volatile, and this makes derivatives riskier compared to traditional financial assets. Additionally, using leverage amplifies both gains and losses, which can result in liquidation of positions if prices move against the trader.
