Crypto derivatives have taken the digital asset space by storm in recent years. While still a nascent sector, the opportunities and advantages it provides to both individual and institutional investors have fueled tremendous growth.

Join us in this blog as we explore what crypto derivatives are, how they work, some examples, and why interest in them continues to gain momentum. Let’s start!

A crypto derivative is a financial contract that links its value to an underlying cryptocurrency, such as Bitcoin or Ethereum. Just like traditional derivatives that are based on equities, commodities, or currencies, crypto derivatives derive their value from their underlying asset.

The main types of crypto derivatives are futures, options, and swap contracts. Futures contracts lock investors into buying or selling crypto at a predetermined date and price.

Options give you the right, but not the obligation, to buy or sell. Swaps, on the other hand, allow two parties to exchange the cash flows of one financial instrument for those of the other.

What is the first crypto derivative?

Many credit LedgerX's launch of Bitcoin futures in 2017 as the first crypto derivative, even though derivatives have been present in traditional finance for decades.

But it was really the introduction of perpetual Bitcoin swaps by crypto exchange BitMEX in 2016 that served as the genesis for an entire new asset class.

These derivative crypto contracts allowed speculators to bet on the price of Bitcoin without actually owning the cryptocurrency, opening the doors for both institutional and retail participation in crypto markets in a new, regulated way.

How do crypto derivatives work?

Crypto derivatives derive their value from the underlying asset they are linked to. For example, if you enter a futures contract to buy 1 bitcoin at $40,000 on January 1st and the price of bitcoin on that date is above $40,000, you'll make a profit. If below, you'll incur a loss.

Options function similarly, with the exception that you have the right but not the obligation to trade cryptocurrency. Swaps allow you to effectively gain exposure without holding the underlying crypto.

Most crypto derivatives settle in cash, paying out profits and losses in fiat rather than physically delivering the asset. This makes them more accessible for institutional investors.

What is an example of a crypto derivative?

One of the most popular crypto derivatives is bitcoin futures offered by the Chicago Mercantile Exchange (CME). CME, the largest regulated crypto derivative exchange, saw over $5 billion in Bitcoin futures volume traded on a single day in January 2023.

Each future is equal to one bitcoin and settles in cash. CME also offers Ethereum futures, which work the same way but are based on Ethereum price movements.

On centralized exchanges, perpetual Bitcoin and Ether swaps dominate, as do those offered by Binance, which accounted for over 35% of all derivatives crypto volume during the first quarter of 2023.

With reliable options from regulated venues like Cryptobunq and trustworthy stablecoins underpinning certain contracts, prudent use of these versatile tools should only become more commonplace.

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What are the benefits of crypto derivatives?

As the crypto ecosystem matures, derivatives play an increasingly important role. They provide capital efficiency for investors by allowing leveraged or short-term exposure without fully purchasing the underlying crypto.

This makes it easier to hedge risk or speculate on directionality. Crypto derivatives also offer price discovery benefits, as the crypto derivatives markets frequently lead the underlying spot markets.

From a practical standpoint, regulated derivatives like CME Bitcoin futures alleviate concerns about counterparty risk, lack of insurance, or volatile underlying exchanges seen with some other crypto products.

Additionally, they provide regulated crypto investment options for institutions that meet compliance standards. The benefits of crypto derivatives unlock greater participation across both retail and professional investors.

What is the difference between spot and derivatives in crypto?

The main distinction between spot and derivatives trading in crypto comes down to ownership versus contractually agreed-upon exposure.

Traders in the spot market purchase and hold the underlying cryptocurrencies, taking ownership of the digital assets and exposing themselves to price swings in the market. Derivatives, however, allow for exposure without holding the asset directly.

Through contracts like futures, options, or swaps, traders can bet on crypto price movements without needing the full funds or dealing with direct ownership of the coins themselves.

While spot focuses on ownership, derivatives crypto focus on exposure without ownership based on contractual terms without ownership.

Why do people invest in crypto derivatives?

Several key reasons attract investors to crypto derivatives as an investment tool. As we mentioned earlier, they provide capital efficiency by letting traders control a large position with just a fraction of the funds required for spot purchases.

To help mitigate downside risk, they also enable hedging strategies by shorting crypto coins or betting against movements. Speculation is another huge use case, as derivatives make betting on price direction simpler.

And of course, because they are regulated products, their structure opens them up to professional investors barred from spot markets due to compliance issues. Crypto derivatives offer powerful ways to profit from cryptocurrencies while managing various risks and restrictions.

What is the world's largest crypto derivatives exchange?

Currently, the world's largest crypto derivatives exchange, measured by trading volume, is Binance. In January 2023 alone, Binance saw over $1.4 trillion in derivatives volume traded on its platform. Bybit, a dominant exchange as well, regularly trades over $100 billion per day.

However, the largest regulated exchange is the CME. As mentioned earlier, CME Bitcoin futures saw a record $5 billion traded in a single day. Though "off-chain" in that trades don't settle on-blockchain, CME brings institutional-grade infrastructure, making it very appealing.

Cryptobunq offers traders the ability to use cryptocurrencies, stablecoins such as euro stablecoins, and crypto tokens, providing regulated exposure to price movements through a crypto collateralized by real cash holdings.

The bottom line

Crypto derivatives have revolutionized how investors engage with crypto markets, both from speculative and risk management perspectives. Driven by growing institutional interest, platforms continue to launch products to capitalize on this emerging asset class.

With increased innovation and oversight, crypto derivatives certainly play an important role in supporting the blockchain sector's efforts toward greater accessibility, transparency, and maturity.

While still young, the massive volume numbers demonstrate that crypto derivatives have the staying power to drive further crypto adoption. Investors now have powerful new tools for profiting from cryptocurrency price movements.

If you are looking to enter the growing crypto economy, Cryptobunq is a secure one-stop shop to consider. You can easily integrate with Cryptobunq and start benefiting from the crypto economy seamlessly.

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