Crypto derivatives or derivatives on cryptocurrency are derivative financial instruments based on digital assets. There are several variants of them.

We explain what cryptocurrency derivatives are, what types exist, how to earn with them, and where to buy them.

Table of Contents* The Principle of Operation of Crypto Derivatives

• Why are crypto derivatives needed
• Types of Crypto Derivatives

• Futures
• Option
• Swap
  • CFD (Contract for Difference, контракт на разницу)

• Advantages and risks of crypto derivatives
• Conclusion

What are crypto derivatives

Crypto derivatives are special financial contracts linked to the future value of cryptocurrencies. Simply put, a crypto derivative allows you to profit from the price change of a digital asset without directly purchasing it.

Such tools have come into the Crypto industry from traditional finance and have quickly gained popularity.

In the screen below, the open interest (Open Interest) is depicted. It reflects the total value of all positions in derivatives that have not yet been closed. The screen shows its two components:

• Futures (Futures) — are standard futures contracts with a fixed expiration date;
• бессрочные фьючерсы (Perpetuals) do not have an expiration date and are maintained through periodic payments between market participants.

As of the time of writing the review, the open interest in classic futures is $2.68 billion, while for perpetual contracts it is $791.3 billion.

In the last month, interest in perpetual futures has increased by about $175 billion, while interest in traditional futures has decreased by almost $0.3 billion. This confirms that perpetual futures remain the main instrument in the cryptocurrency derivatives market.

Crypto derivatives statistics. Source: CoinMarketCap## The principle of crypto derivatives

A crypto derivative is essentially a contract between two parties – a buyer and a seller – for the execution of a cryptocurrency transaction in the future under agreed terms. The participants of the contract fix the price and the deadline for the transaction, while the underlying asset (, for instance, Bitcoin ), may not belong to them. The subject of the transaction is the right or obligation to buy or sell this asset in the future at a predetermined price.

The principle of operation of such a contract is similar to a pre-order for goods. For example, a buyer enters into an agreement with a car dealership to purchase a car of a specific model for a fixed amount, with the receipt of the car in a few months. Even if the market price of the car increases during this time, the buyer will pay exactly the agreed amount and will not overpay, while the seller is guaranteed to sell the product. Similarly, a cryptocurrency derivative fixes the price: if at the time of contract execution the price of Bitcoin has risen, the buyer benefits, and if it has fallen, the seller profits. Thus, crypto derivatives provide the opportunity to agree on a price in advance and profit from subsequent price changes without owning the asset itself.

It is important to understand that classical derivatives are futures ( that have a term ) instruments. On the specified day, the contract is either executed ( if it obliges to sell/buy ), or it expires.

Many derivatives require the trader to deposit collateral (margin). Margin serves as a guarantee for the fulfillment of obligations and covering potential losses. If the market goes against the trader's position and there are not enough funds in the account to maintain the position, it will be forcibly liquidated by the exchange. Therefore, it is not possible to simply ride out a strong decline, as with the simple purchase of an asset – it is important to monitor the sufficient margin level.

Why are crypto derivatives needed

Traders and investors use crypto derivatives for various purposes:

• Hedging. Insurance against risks and protection from sharp price fluctuations. For example, a mining farm can sell a futures contract on bitcoin in advance to lock in the current selling price of the future mined coin and protect itself from a possible drop in the exchange rate.
• Speculation. Earning on price fluctuations, including price drops. With the help of derivatives, one can open short positions and make a profit when the cryptocurrency decreases in value. For example, by selling a bitcoin futures contract, a trader will profit if the price of BTC drops by the contract's expiration date. Derivatives allow trading the asset without owning it, which simplifies short selling (shorting).
• Leverage. Increasing potential profits through borrowed funds. Many derivative exchanges offer trading with leverage (leverage). This allows for operating with an amount greater than the trader's own capital. For example, a 5% price increase with a 5× leverage will yield a 25% profit on the invested capital. However, losses in the event of an unsuccessful trade will also increase proportionally. Due to the built-in leverage and relatively low fees, crypto derivatives are particularly popular among active day traders. However, using high leverage without experience is extremely risky – one can quickly lose the entire deposit.

Top 10 Crypto exchanges by trading volume of derivatives. Source: CoinMarketCap## Types of crypto derivatives

There are several main types of crypto derivatives. Let's take a look at them.

Futures

A standardized exchange contract for the purchase or sale of an underlying asset at a specified date in the future at a fixed price. Futures obligate the execution of the transaction under the specified terms.

An example of a futures contract from real life is a pre-order of goods at a predetermined price with delivery in the future. On the day of futures execution, the parties either exchange the asset and money or settle the price difference ( depending on the type of contract ). Futures for Bitcoin, Ethereum, and other coins are available on crypto exchanges. They are used for speculation both on price increases and decreases.

Perpetual Futures (perpetual swap) – a special type of futures contract without an expiration date. In terms of functions, it is similar to a regular futures contract, but the position can be held for as long as desired. To ensure that the price of the perpetual futures does not deviate too much from the spot price of the asset, exchanges introduce a funding mechanism (funding): holders of long and short positions regularly pay each other a small fee depending on which way the price of the contract is moving.

Forward (forward contract) is almost the same as a futures contract, but is concluded over the counter (on the OTC market) directly between the transaction participants. A forward contract is not standardized; its terms are determined independently by the parties. Like a futures contract, a forward involves a future purchase/sale of an asset at an agreed price, but due to its over-the-counter nature, it carries a greater risk of non-fulfillment of obligations (counterparty risk).

Option

A derivative contract that gives the right, but not the obligation to buy or sell the underlying asset at a predetermined price until a specified date. The option buyer pays the seller a premium for this right. There are two types of options:

• Call (колл) – right to buy
• Put (put) – the right to sell the asset

If the option expires and it is not profitable to exercise the right, for example, the price has moved in the wrong direction, the buyer simply refuses to exercise it – their losses are limited to the premium paid.

Example of an option in life: an agreement with a store seller to reserve a product at an agreed price; you can buy the product later or refuse, losing only the deposit (premium).

( Swap

A more complex derivative instrument that combines two interrelated transactions. The first stage of the swap involves the purchase/sale of the underlying asset now, and the second involves the reverse transaction in the future under agreed terms. Thus, the swap allows for an immediate exchange of assets or payments, agreeing on a subsequent reverse exchange. Swaps are commonly used for exchanging interest payments or currencies, but there are also crypto swaps.

A simple example: a company buys a product from a supplier today and simultaneously enters into an agreement to sell that product to a buyer in a year at a fixed price. Essentially, the swap locks in the asset's value and profit in advance, combining two transactions into one.

) CFD ###Contract for Difference, контракт на разницу###

An agreement in which the seller and buyer pay each other the difference between the price of the underlying asset at the time of the contract and the price at the time of its closure. The asset (, for example, bitcoin ), is not actually purchased – the trader is essentially betting on the rise or fall of the rate. If the price of the asset has increased during the term of the CFD, the seller of the contract pays the buyer the difference in price; if the price has decreased, the buyer pays the seller.

Analogy: the store promises to refund the customer the price difference if after purchase the customer finds the item cheaper elsewhere.

Advantages and Risks of Crypto Derivatives

Crypto derivatives provide new opportunities for earning, but are associated with increased risk. Below are their key pros and cons:

| Pros | Cons | | --- | --- | | Earnings on any price movement. You can profit from both the rise and fall of the exchange rate. Derivatives allow you to short crypto assets – sell them to buy back cheaper if a price drop is expected. This is not available in regular spot trading, where income is possible only when prices rise. | High volatility and risk of losses. Cryptocurrencies are very volatile, and trading derivatives on them carries high risk. With an incorrect forecast, you can quickly lose a significant amount. If leverage is used, losses can far exceed the initial deposit. In some cases, a trader can lose all funds and even end up owing the broker (negative balance). | | Hedging Risks. Derivative instruments help protect against unfavorable market changes. An investor can insure their portfolio against price declines using options or futures, thereby reducing losses in case of a crisis. Crypto derivatives were initially created specifically for managing risks in a volatile market. | Complexity and Knowledge Requirements. Derivatives are complex instruments that require an understanding of market mechanics. Knowledge of margin, position liquidation, contract pricing, and so on is necessary. Without sufficient experience and training, there is a high likelihood of making a mistake and incurring losses. It is difficult for a newcomer to immediately understand all types of derivatives and trading strategies. | | Leverage and capital efficiency. The ability to trade on margin allows traders to open large positions with a small initial capital. This increases the potential return on capital – funds are not fully "frozen" in the asset, as with spot purchases, and can be utilized more flexibly. Additionally, derivative markets typically have higher liquidity and lower fees than spot markets, especially for popular contracts, which attracts professional traders. | Additional costs and platform risks. Holding a position on certain derivatives incurs fees (for example, a funding fee every 8 hours on perpetual contracts). Long-term margin trading also accumulates interest. Furthermore, there is a risk of issues with the platform itself: if a broker or exchange goes bankrupt, traders may lose the funds in their accounts. This happened during the collapse of the FTX exchange in 2022, when clients lost access to their deposits. Regulators worldwide warn that retail investors should be especially cautious with derivatives on cryptocurrencies. |

Conclusion

Crypto derivatives are a powerful tool that, when used wisely, helps manage risks and generate profits in various market situations. They have already taken an important place in the ecosystem: from hedging by large investors to speculative trading with high leverage. However, newcomers should not rush to dive into complex derivative transactions.

Experts recommend first understanding the basics of trading, practicing in the spot market, and thoroughly studying the principles of derivatives. Only after gaining experience and developing a risk management strategy can one move on to operations with crypto derivatives.

Remember that any leveraged trades carry increased risk, and they should be used mindfully. With the right approach, crypto derivatives can become an effective addition to the strategy of both novice and experienced investors, opening new horizons in the dynamic cryptocurrency market.

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