What are crypto derivatives, and how do traders profit from them?

A derivative is a financial contract on the future price of a cryptocurrency, security, commodity or service. The subject of such a contract is called the underlying asset. Buyers and sellers of derivatives do not own the underlying assets; they buy and sell the right to execute the contract.

To reduce risk and to profit from price moves. This applies to both traditional and crypto exchanges. Here are some examples.

If trader Vasily fears that bitcoin will drop to $3,000 by next Tuesday, he can make a contract with trader Arkady to sell him bitcoins when the price falls to $3,500. In this way, derivatives help reduce risk.

And if trader Gennady wants to buy bitcoin at $3,500 before Tuesday, he can buy the contract from Arkady, and then Vasily will sell the bitcoins to Gennady instead. Vasily receives money from Gennady without waiting for the agreed price. By selling and buying this contract, traders can earn depending on the price of the underlying asset. This is how derivatives are used to make money.

Traders profit from changes in the price of the underlying asset. Because the future market price of the underlying is unknown, all participants take on risk. If by the time the contract is settled the asset has fallen, the seller profits and the buyer loses. If the asset has risen, the buyer gains.

To amplify returns, a trader uses leverage — a loan provided by the exchange. The size of the leverage is proportional to the trader’s deposit. This allows larger trades. The amount of leverage depends on the exchange. Most exchanges charge a fee for leverage.

Suppose the current BTC price is about $8,000. Arkady expects it to fall. He deposits 1 BTC on an exchange, chooses 10x leverage and sells 80,000 contracts at $8,000 per 1 BTC. Two hours later, bitcoin drops to $7,600. Arkady then buys back the same contracts and books a net profit of 80,000/7,600 − 80,000/8,000 = 0.52 BTC. He now has 1.52 BTC in his account.

Note: the sponsor of this card, ShortBit, does not charge a fee for leverage. The exchange earns from standard transaction fees. Fees on ShortBit are 0.075% for sellers and 0.025% for buyers.

• Futures
• Forwards
• Options
• Swaps
• CFD (contract for difference)

A futures contract is an agreement to sell or buy the underlying asset at an agreed price in the future (hence the name). For example, you order a specific car configuration at a dealership. It will be delivered in six months, and you will be obliged to buy the car at the agreed price.

There are also perpetual futures. They have no settlement or expiry date, so they can be bought and sold at any time.

The exchange ShortBit offers perpetual futures contracts on the price of bitcoin, Ethereum and Binance Coin. Derivatives on other cryptocurrencies will be added in future.

A forward is an over-the-counter agreement to buy or sell a good in the future. It resembles a futures contract but is less standardised. A futures contract trades on an exchange, whereas a forward is done OTC. For example, you undertake to translate a book in future, and the publisher undertakes to pay for the finished work.

Bitcoin forwards are traded on the US‑regulated exchange TeraExchange.

An option is a contract that gives the buyer the right, but not the obligation, to buy a good at an agreed price. For example, you ask a shop to hold a product until tomorrow because you do not have cash with you.

Options trading is available on Deribit and LedgerX.

A swap consists of two contracts: the purchase and sale of the underlying asset, and the purchase and sale of the same asset in the future. It is a more complex variant of a futures contract. For example, you buy a car in a specific configuration and simultaneously agree with an acquaintance that you will sell that car to him at a higher price.

Perpetual swaps are available on the BitMEX exchange.

A CFD (contract for difference) is a derivative on the difference in prices of an underlying asset. If during the life of the contract the asset has risen, the seller pays the difference. If it has fallen, the buyer pays it. Such contracts are often perpetual and are closed by the party entitled to do so under the agreement. For example, a shop promises to refund the price difference if you find the same product cheaper.

Crypto CFDs are available on the eToro platform.

The material was prepared in cooperation with the crypto-derivatives exchange ShortBit.