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A derivative is a class of financial contracts that derive their value from the performance of an underlying entity. Derivatives where this underlying is a cryptocurrency or a cryptoasset, e.g. Bitcoin, Ether etc are known as cryptocurrency derivatives. Trading of crypto derivatives does not entail actual buying or selling of bitcoins or any other crypto. The value of the derivative contract changed with the change in price of the underlying cryptocurrency and thus, trading derivatives in an alternative way to get exposure to the underlying cryptoasset or crypto currency .
The prominent types of derivative contracts include futures, options, contracts for difference (CFD), perpetual swaps and swaps. Derivative contracts are traded both on exchanges and over the counter (OTC). Exchange traded derivatives are standardised contracts and are typically very liquid. In contrast, OTC derivatives are bespoke contracts between two parties.
There are broadly, three categories for derivative use-cases.
(a) hedging: this is essentially getting insurance for adverse price movements of an asset you already own. For e.g. miners may want to lock-in the price of mined bitcoin without selling it,
(b) speculation: traders employ derivatives to create leveraged pay-off profiles based on
their market view, and
(c) access: traders that are not able to buy bitcoin or cryptocurrencies directly could potentially gain exposure to them via derivatives.
For traders/ investors, derivatives offer several benefits which are unavailable in spot trading.
(a) ability to go both long and short, i.e. profit from both rising and falling market,
(b) leverage trading which enables a trader to take bigger positions and
(c) strong liquidity which reduces the cost of trading.