Investing in Crypto Derivatives: Futures and Perpetual Contracts

Investing in cryptocurrency without holding actual Bitcoin is possible through financial instruments such as derivatives. In this article, we will explore what crypto derivatives are, with a focus on futures and perpetual contracts, and how they differ.

What are Crypto Derivatives?

Crypto derivatives are financial contracts that derive their value from cryptocurrencies. They allow parties to speculate on the price of the underlying cryptocurrency on a future date. For instance, a futures contract has two parties agreeing on a buying and selling price of the cryptocurrency in one month, irrespective of the actual price.

Types of Crypto Derivatives

Crypto derivatives come in various types, including options, swaps, futures, and perpetual contracts. This article will focus on futures and perpetual contracts, which differ depending on the conditions of the contract.

Crypto Futures Crypto futures are legal agreements between two parties to buy or sell an asset at a predetermined price on a future date. Before getting into the contract, the parties agree on two things: the exchange price and the expiration date.

Practical Example: Two crypto derivative traders, Mercy and Frank, enter into a futures contract when the price of Bitcoin is $30,000. Mercy is bullish, believing that Bitcoin will surpass $30,000 in a month, while Frank is bearish, thinking the price will drop below $30,000.

Scenarios for Profit or Loss:

1. Mercy was right, and the price of Bitcoin goes up to $37,000. She purchases Bitcoin from Frank at a discount, making a profit of $7,000.
2. Mercy was wrong, and the price of Bitcoin drops to $25,000. She buys Bitcoin from Frank at the agreed $30,000, losing $5,000, while Frank makes a $5,000 profit.

Crypto Perpetual Contracts Crypto perpetual contracts are similar to futures, but they have no expiration date. Investors can hold their positions for as long as they like. They have price pegs to ensure that they trade at prices equal or almost equal to the spot market prices.

Perpetual contracts have a funding premium that maintains the price peg between contract sellers and buyers.

Practical Example: Mercy invests in a perpetual contract when Bitcoin's price is around $30,000, anticipating an increase in the price. After two months, Bitcoin's price goes up to $40,000, and Mercy makes a profit of $10,000.

Leverage Opportunities Derivatives like futures and perpetual contracts offer leverage opportunities that allow traders to open trading positions bigger than their capital. For instance, a derivative exchange offering two times leverage means that a trader's capital doubles, and so does their profit. However, leverage also amplifies losses and increases the risk of being liquidated.

Conclusion Crypto derivatives offer investors a way to invest in cryptocurrency without holding actual Bitcoin. Futures and perpetual contracts are two types of crypto derivatives with different conditions. Futures have expiration dates, while perpetual contracts do not. Perpetual contracts have price pegs and funding premiums, while futures do not. Finally, derivatives provide leverage opportunities that amplify profits and losses, hence increasing the risk of being liquidated.