Getting Down to Brass Tacks About Derivatives Crypto Trading

Crypto trading is becoming familiar. Like the people getting acquainted with the stock market trading, the crypto trading is becoming similar fashion as almost most of the population in the United States and in other countries are getting familiar with crypto trading. But do they know about various trading methods that the cryptocurrency exchange provides for their user? No. Because, despite the similarities between stock trading and crypto trading, the trading methods slightly vary from the latter to the former.

Of all the trading measures, derivatives trading is one of the most viable trading features that most of the leverage marketers would love to invest and trade. Here, in this blog, let us know all the ins and outs of derivatives trading with a special focus on the two main types of derivatives — futures and perpetual contracts.

What is Derivatives Trading?

Derivatives trading is a method of crypto trading conducted between two or more parties based on the underlying asset. They do not trade actually on the asset itself. Rather they would calculate the future profits that the particular trade will bring on and trade on profit that the particular asset would get. Derivatives trading applies to all kinds of assets either be it a digital property or a physical property. This kind of trading feature is accepted between the traders in form of contract on two factors — Either they can mitigate the risk in the future (Hedging) or predict the risk and mitigate them( speculation) with respect to the consummate reward.

Crypto derivatives trading works similarly to normal derivative trading. The only difference is the usage of the digital asset — Crypto. Derivatives trading is mostly preferred by those target specific traders who are experts in the trading arena. But knowing the types and their significance can help you to master crypto trading in a short period.

Types of Derivatives Trading:

Derivatives trading is done in two methods — The lock method and in Options method. Lock methods involve Futures contract trading, forward contracts, swaps, etc. The options trading involves optional contracts and other associated contracts, etc. The lock method is the most preferred type of derivative trading that is conducted more often. A futures contract, Forward contract, swaps, and warrants are the most peculiar yet preferred type of derivative trading used in the trading field. And in the cryptocurrency sector, there are two types of contracts that are focussed when it comes to derivatives. They are Futures contracts and perpetual contracts. Let us get to know about them in detail:

Futures contract:

A future contract is a type of derivative trading where the trade is time-framed. It is done based on the future settlement price and along with the date fixation. The date or the amount fixed cannot be changed unless the trade is over. It works for both centralized and p2p trading exchanges. To make it more clear, let me come with an example.

A and B are two traders and B wants to involve in future contracts by trading bitcoins. B believes that the price of bitcoin will increase in the future. So, he fixes the price of 1 bitcoin at $30k. He fixes the trade should happen on the 28th of January 2021. Now A wants to involve in trade with B and engages with B to further up the trade. This is a future contract. A and B hereby fixes the trade should happen on the prescribed date (settlement date) at a prescribed price level. A can only hold the position of the bitcoin until the settlement date in which it gets automatically traded for the fixed price to A after expiry. If the price level of the bitcoin rises above $30k on 28th January 2021, say $38k, then B loses the profit by $8k. But if the price further goes down at that time of selling, say $25k, then it is a profit for B. In the meantime, A can involve in any kind of trade any number of times irrespective of the price range before the expiration or settlement date. That does not affect the seller B.

This is a contract based trade that relies entirely on the prediction methodology. This does not mean that you cannot make a successful trade if you are a novice. All you need to do is to analyze the market and make approximate predictions so that you can earn a profit by trading. Considering this future contract, the perpetual contract is different.

Perpetual contract:

The perpetual contract is similar to a futures contract. The only difference is that they do not have any time limit for settlement. That means, they do not have an expiry of trade and the seller can sell the bitcoin or any other cryptocurrency whenever the coin reaches the predetermined price limit. The perpetual contract does have some unique areas which differentiate it from the former.

Perpetual contracts process based on three functionalities: Futures contract do have these functionalities but we can see them in regard to the perpetual contract:

  • Initial Margin
  • Maintenance Margin
  • Insurance Fund

The Initial Margin and the Maintenance margin are the two margin trading options that the perpetual contracts work on. Let me explain you with an example:

  1. You buy 100 coins worth $1000. You want to increase the investment and you leverage the amount to 9 times so that you have 1000 coins for $10,000.
  2. Here, your Initial investment of 100 coins and $1000 dollars would be set as an initial margin. This is the collateral in which you have to maintain.
  3. The maintenance margin would be set at $9000 dollars in which when there is a dip in the market and if the price of the coin goes below $9000, then you would get a Margin call. That is a liquidation call.
  4. You can either liquidate the collateral or you can invest further to maintain the margin.
  5. During the Margin call, if you are capable enough to fill up the leverage or collateral that you have lost in the trade, then you can continue the trade.
  6. Or else, the maintenance margin would be dropped off and the leverage amount would be returned to your account and the entire trade will be closed altogether.

This is how the perpetual contract works. But what happens when a trader goes far beyond the collateral limit that he receives a negative balance. That is where the Insurance fund comes to the rescue. For example, let us say, A is at the liquidation stage where he could not further invest to maintain the margin. But the price of the coin goes further down that A receives a negative balance. Then the insurance fund manages to pay the debt amount to make the balance to Zero so that he can take out the funds from the perpetual contract.

Types of Mode in cryptocurrency derivative trading:

  1. One way mode — If you are bidding or trading a long or short position, then only one type of order could be bidded or traded. If you want to be involved in any other trade, the previous order would be closed and then the present order would be taken into consideration. For example, if you are trading 10 tokens and you need a new trade of 15 tokens, then the trade of 10 tokens would be closed and extra 5 tokens would be added to the trade.
  2. Hedge Mode — You can hold any number of positions irrespective of their long or short position. For example, if the market is bullish and the bearish in the short time frame, then the marketers who were holding long positions would sell off their trade on the expectation that the bearish would continue for a pretty long time to prevent huge losses.
  3. Cross Margin — In cross margin, the long and short positions would be sharing the position of the unrealized profit and loss.
  4. Isolated margin — This is the margin where the individual can manage the risk based on the isolated liquidation instead of entire liquidation criteria. For example, when the funds in the maintenance margin is at the crossroads that it demands liquidation, through isolated margin, a trader can manage to leverage an isolated margin amount to continue the trade and maintain the trade.

Final words:

Crypto Derivative trading increases the efficiency of the cryptocurrency exchange platforms and makes the trade more active. There are other such trading types that involve short to long-term trading criteria but with derivative trading, you can involve in two extremes of the trading — both perpetual and future contract. Finally, you have learned how to do both types of derivative trading and this is the right time to implement them and earn huge profits. If you are a cryptocurrency exchange service provider, then you need to induct these trading features to meet up with more user engagements.




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Sasha Ortiz

Sasha Ortiz

International team of Bitcoin and Cryptocurrency consultants & specialists will be able to advise you on various topics of virtual currencies.

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