Cryptocurrencies have emerged as an exciting asset class for investors. As a trading asset in its infancy stage, majority of trading has been spot crypto trading, with many unaware of crypto derivatives as an exciting new trading product.
As the crypto market gradually develops, cryptocurrency derivatives have emerged as an attempt to level it to the scale, liquidity and accessibility of forex trading— opening crypto to a class of traders typically from the traditional realm of the Wall Street.
Crypto derivatives became an attractive option as new financial instruments especially in a bear market, which has engulfed the industry since January 2018. Before that, crypto spot traders were busy enjoying the spoils of an unprecedented bull market where the price of Bitcoin jumped nearly 2000% from $1000 at the start of 2017 to above $19,000 by December 2017.
However, the bear market necessitated the need for traders to temper expectations and institutions to look for newer ways to manage their risks. As volumes remained stagnant in crypto spot trading, crypto derivatives came into the mainstream to satisfy the need for smart trading opportunities.
Derivatives trading products also bring in a lot of sophisticated tools and features which help investors execute complex strategies and generate profits and enable financial institutions to hedge their positions in the underlying markets.
Spot trading is a popular way for investors to access the cryptocurrency market as it is straightforward for the novice trader. No need to understand leverage, margins and other tools associated in traditional financial trading. The strategy is simple: Get a crypto wallet, buy a preferred crypto asset, and upon increase in price, sell the asset to make a profit. This straightforward method makes it easy for investors to generate profits in the cryptocurrency markets. Most of the Bitcoin and altcoin trading in 2017–18 was done through cryptocurrency exchanges which exploded across every country.
Traders also have the opportunity to trade cryptos with one another through crypto-to-crypto trading. Binance’s meteoric rise in the cryptocurrency industry was driven by this phenomenon. By making it easy to perform fiat-to-crypto trading, crypto-to-crypto trading, storage of cryptocurrencies, deposits and withdrawals, exchanges have played a pivotal role in the cryptocurrency space by simplifying spot trading for investors.
Derivatives instruments have long been popular for other traditional financial products, as they have already matured in the international stock markets and are traded in huge volumes. Derivatives has the potential to generate significant profits as compared to traditional spot trading, irrespective of market conditions.
There common derivatives products in the financial world include Swaps, Futures, Contracts for Difference (CFDs) and Options. Since the cryptocurrency industry is nascent, there are only a few popular cryptocurrency derivatives available for traders currently. Many other derivatives instruments such as Bitcoin and Ethereum futures are also popular among traders.
Benefits of Cryptocurrency Derivatives vs Spot Crypto Trading
Cryptocurrency derivatives trading offer a lot of advantages over spot crypto trading:
Derivatives can be the quickest route to get in on the crypto action for investors. With cryptocurrencies being a relatively new concept for most mainstream investors, there is no need to register for crypto wallets and understand crypto jargon needed to hold your assets such as, hot and cold wallet, private and public key, et cetera. Some may prefer the sheer simplicity of trading derivatives on an exchange and not have to worry about where to buy crypto, being responsible for remembering your own username and key with no ‘password reset’, or fear losing all assets if you lost your crypto wallet.
One great advantage with crypto derivatives over spot trading is the ability to trade cryptocurrencies with leverage. This means that traders only need a small startup deposit to make a stronger overall position.
With leverage, derivatives gives traders the potential to amplify returns as compared to spot trading. In spot crypto trading, profits are limited to the amount of cryptocurrencies you hold in your portfolio. It is difficult for a small investor to have enough underlying assets to generate meaningful profits, especially in a bear market. With leverage, traders get a chance to maximise the potential of a returns with a much smaller initial capital.
Trade in Any Market Condition
Fundamentally, derivatives allow traders to speculate on price movements of the underlying cryptocurrencies. With derivatives, traders do not own the underlying asset and instead have the opportunity to trade on price direction.
Short and long positions help you to generate profits, regardless of the direction the price of the crypto asset moves in. For instance, if you think that the market is going to spiral downwards, you can take a short position and gain profits. With spot trading, your only option in such a scenario is to HODL or sell at a loss.
Access to Trading Tools
Just like trading forex, derivatives traders can gain access to typical trading tools that help traders manage their risk and trading appetites, such as ‘stop loss’ and ‘take profit’ tools available on popular trading platforms. Stop losses are great because it automates the ability to close positions and limits losses in case the market is not responding favourably. Take profit feature allows you to lock in the profits before the price of the cryptocurrency declines. While many exchanges are now coming up with such features, they have been long available on derivatives trading platforms.
A lot of financial firms and investors use derivatives instruments to hedge their portfolio. Derivatives are part of an active risk management strategy used by many institutions. Consider hedging like an insurance for your cryptocurrency portfolio. This allows you to be comfortable in any position, regardless of a bull or bear market.
The recent Binance hack showed that even the world’s leading cryptocurrency exchange is not safe from security breaches. Most investors store their assets on exchanges and only a few go through the entire process of setting up a cold wallet to secure their cryptocurrency holdings. Private key storage is also a huge friction point for investors trading in spot markets. Unlike spot crypto trading, crypto derivatives removes the hassle of storage of cryptocurrencies and allows you to trade against the price movements.
Lessons for Brokers and Institutions
Brokers need to ensure that they give customers peace of mind through regulated avenues of trading, along with deep pools of liquidity. Customers should be able to trust your business with their hard-earned money in a highly volatile environment. A good brokerage firm is able to provide smart leverage options with tight spreads and a good selection of crypto CFDs.
At Broctagon, we understand the advantages that cryptocurrency derivatives bring to the table. That’s why we have built a tool which elevates the advantages of crypto derivatives trading by unlocking the power of aggregated global crypto liquidity. The Broctagon Network of Exchanges for Universal Settlement (NEXUS) allows prime exchanges, brokers, and financial institutions to access the forex standard of deep, multilateral, ECN liquidity for the first time ever. The CySEC-compliant NEXUS platform aggregates liquidity from prime crypto exchanges and seamlessly distributes it to a global network of brokers, MTFs, and crypto exchanges.
We recently added additional features which offer our partner firms more avenues to access 90% of global tradeable assets from one single account denominated in stablecoins, fiat and/or Bitcoin. End users can now easily create diverse portfolios along with settlements in stablecoins such as USDT.
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The highly leveraged nature of futures trading means that small market movements will have a great impact on your trading account and this can work against you, leading to large losses or can work for you, leading to large gains. This article does not, in any form, constitute financial advice. If you do not fully understand these risks you must seek independent advice from your financial advisor. All trading strategies are used at your own risk.