What is Derivatives Market in Trading?
A derivative market in crypto is a market where financial contracts whose value is derived from the underlying asset are traded. The underlying asset can be anything, including crypto assets like Bitcoin or Ethereum.
In a derivative market, traders can buy and sell derivatives contracts, which allow them to speculate or hedge on the future price of the underlying asset. Hedging is when you use derivatives to offset the risk of price fluctuations in the underlying asset. Speculation is when you use derivatives to bet on the future price of the underlying asset.
Types of Derivatives
The cryptocurrency market is a very new and rapidly evolving space, and as such there are a number of different types of derivative markets that have emerged.
Here are some of the most popular:
- Futures Markets: Futures contracts are agreements to buy or sell an asset at a future date at a price that is agreed upon today. These contracts are often used to hedge against price fluctuations or to speculate on the future price of an asset. The Chicago Mercantile Exchange (CME) and the Chicago Board Options Exchange (CBOE) both offer Bitcoin futures contracts
- Options Markets: Options give the holder the right, but not the obligation, to buy or sell an asset at a specified price on or before a certain date. They can be used to hedge against price fluctuations or to speculate on the future price of an asset. The CBOE offers Bitcoin options contracts.
- Swap Markets: A swap is an agreement between two parties to exchange one asset for another asset, usually at some future date. Swaps are often used to hedge against price fluctuations or to speculate on the future price of an asset. The most popular type of swap is the interest rate swap, which involves exchanging a fixed interest rate for a floating interest rate.
- OTC Derivatives Markets: Over-the-counter (OTC) derivatives are traded between two counterparties, typically without the need for a centralized exchange. This allows for a greater degree of customization, but also comes with more counterparty risk. OTC derivatives markets are often used to hedge against price fluctuations or to speculate on the future price of an asset.
Who are the Participants in the Derivatives Market?
The participants of a derivatives market are responsible for the lively market. Such participants include:
Since derivatives are suitable for hedging, the market is flooded with them. These are investors who reduce risk. They minimize their chances of getting burnt by the market by considering volatility and maximizing their risk.
These refer to those investors who invest in speculative assets for the sole purpose of making massive profits. Unlike the hedgers who minimize risks, the speculators take high risks.
These refer to those investors who rely heavily on profiting off volatility and comparing prices of the same underlying asset on different platforms for profit-making.
- Margin traders
These are investors who invest based on credit. They put forward collateral in case the investment isn’t profitable. The collateral helps to cover such risk.