How do crypto derivatives work?

Understanding the various financial instruments available is important for anyone looking to navigate the crypto market. One instrument that has gained significant traction is crypto derivatives. What are crypto derivatives? Crypto derivatives are contracts that derive their value from an underlying cryptocurrency asset, enabling traders to speculate on price movements, without necessarily owning the asset itself.

As the crypto market matures, derivatives have become increasingly popular among traders seeking to enhance their strategies and manage risk. In this beginner's guide, we will explore the different types of crypto derivatives, how they operate, and provide practical insights into buying and swapping tokens using Trust Wallet.

What Are Crypto Derivatives?

Crypto derivatives are financial contracts that derive their value from the price of an underlying cryptocurrency asset. Crypto derivatives enable traders to speculate on price movements, without actually holding the cryptocurrencies. This can be particularly advantageous in a volatile market, where quick trades can lead to significant profits or losses.

These derivatives come in various forms, each offering unique features and benefits. They are primarily used for two purposes: speculation and hedging. Speculators aim to profit from price fluctuations, while hedgers seek to protect their investments from adverse price movements. The growing interest in crypto derivatives reflects the increasing sophistication of traders and the desire for more complex trading strategies.

How Crypto Derivatives Work

Crypto derivatives operate on the principle of contracts between buyers and sellers, enabling traders to speculate on the future price of an underlying cryptocurrency. Here’s a closer look at how these instruments function:

Contracts

At the core of crypto derivatives are contracts that stipulate the terms of the trade. The contracts outline the price at which the trader agrees to buy or sell the underlying asset at a future date.

Price Movements

The value of a derivative is influenced by the price fluctuations of the underlying cryptocurrency. For example, if a trader enters into a futures contract to buy Bitcoin at $30,000, and the price rises to $35,000 before the contract expires, they can sell the contract for a profit. If the price drops to $25,000, they may incur a loss.

Types of Trading Strategies

Traders can adopt two main types of positions when engaging with crypto derivatives: long or short. A long position is taken when a trader believes that the price of the underlying cryptocurrency will rise; in this case, they buy a contract with the expectation of profiting from the price increase. A short position is pursued when a trader anticipates that the price will fall; by selling a contract, they stand to profit if the price indeed decreases.

Settlement

Settlement of crypto derivatives can occur in two primary ways, depending on the type of contract involved. In physical settlement, the actual cryptocurrency is exchanged between the parties at the contract's expiration, meaning the buyer receives the cryptocurrency while the seller receives the agreed-upon payment. Alternatively, in cash settlement, traders do not exchange the cryptocurrency itself; instead, they settle their profits or losses in cash based on the difference between the contract price and the market price at expiration. This method enables a simpler transaction, without the need for physical transfer of assets.

Exchanges

Crypto derivatives are typically traded on specialized exchanges that facilitate these transactions. These platforms provide liquidity and enable traders to enter and exit positions quickly.

Many exchanges offer leverage in trading crypto derivatives. Traders can control larger positions than their actual investment by borrowing funds. This practice can amplify potential returns but also increases risk, as it can lead to larger losses if the market moves unfavorably.

Types of Orders

Traders can use various order types when trading crypto derivatives:

• Market orders: Executed immediately at current market prices.

• Limit orders: Set at a specific price; executed only when the market reaches that price.

• Stop-loss orders: Designed to limit losses by automatically selling a position when it reaches a predetermined price.

Types of Crypto Derivatives

Crypto derivatives come in several forms, each designed to meet different trading strategies and risk profiles. Understanding the various types can help traders choose the right instruments for their investment goals. Here are the most common types of crypto derivatives:

Futures Contracts

Futures contracts are agreements to buy or sell a specific amount of a cryptocurrency at a predetermined price on a set future date. The contracts are standardized and traded on exchanges, making them highly liquid. Traders use futures for both speculation and hedging purposes.

Options Contracts

Options contracts give traders the right, but not the obligation, to buy or sell an underlying cryptocurrency at a specified price before or on a certain date. There are two main types of options:

• Call options: Call options give the holder the right to buy the underlying asset at a predetermined price. Traders purchase call options when they expect the asset's price to rise.

• Put options: Put options grant the holder the right to sell the underlying asset at a predetermined price. Traders buy put options when they anticipate a decline in the asset's price.

Swaps

Swaps are agreements between two parties to exchange cash flows based on the value of an underlying asset. In crypto trading, swaps often involve exchanging one cryptocurrency for another or converting between fiat currencies and cryptocurrencies. The most common type is the crypto swap, where traders can exchange one crypto asset for another without needing to convert it back into fiat currency first.

Perpetual Contracts

Perpetual contracts are similar to futures contracts but do not have an expiration date. This enables traders to hold their positions indefinitely as long as they meet margin requirements. Perpetual contracts often include mechanisms like funding rates, which are periodic payments exchanged between long and short position holders based on market conditions. This feature helps keep the contract price in line with the underlying asset's spot price.

How to Buy Tokens Using Trust Wallet

Here’s how to buy tokens using Trust Wallet, via our trusted partners. In this example, we’ll show you how to buy BTC:

• Select “Buy” from the home screen.

If using the mobile app:

• Search for “Bitcoin” or “BTC” and select it.

• Choose your preferred currency, then enter the amount of BTC you want to purchase.

• Select the third party provider & payment method you’d like to use.

• Select the “Buy button” and complete the remaining steps.

If using the browser extension:

• Choose your preferred currency and amount, then choose Bitcoin (BTC).

• Select your preferred third party provider.

• Complete the remaining steps.

How to Swap Tokens Using Trust Wallet

You can easily swap tokens using Trust Wallet, thanks to the built-in decentralized exchange (DEX) feature. Here’s how to use Trust Wallet swaps: In this example, we’ll swap SOL for BODEN.

• Select “Swap” from the Trust Wallet home screen.

• Ensure Solana is selected in the “From” network field, and choose SOL as your token.

• Ensure Solana is selected in the “To” network field, and choose BODEN as your token.

• Enter the amount of SOL you would like to swap.

• Select “Continue” and complete the remaining steps.

Closing Thoughts

Understanding crypto derivatives is essential for navigating the dynamic cryptocurrency market. These instruments provide opportunities for speculation and risk management, but they also come with inherent risks. Familiarizing yourself with different types of derivatives can help you develop effective trading strategies. Tools like Trust Wallet make it easy to buy and swap tokens. As you explore this exciting space, remember to Do Your Own Research (DYOR).

Disclaimer: Content is for informational purposes and not investment advice. Web3 and crypto come with risk. Please do your own research with respect to interacting with any Web3 applications or crypto assets. View our terms of service.

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Note: Any cited numbers, figures, or illustrations are reported at the time of writing, and are subject to change.