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Bitcoin has come a long way in its eleven or so years of existence. It was created to be a ‘peer-to-peer electronic cash system’, but it has become so much more than that today. In fact, Bitcoin has crossed over quite significantly from being a currency to being more of an investable asset.
Cryptocurrency continues to find its niche in the world and an application that can see it ingrained into mainstream usage. Currently, it is finding its use for investors who see the potential in its market for big gains. This again started in the early days with individual investors buying and holding onto the digital currency as it appreciated in value. However, today there is a thriving and bustling trading community around Bitcoin too.
Bitcoin trading has branched out far more than just being about buying and selling at different price points — it has expanded into the traditional trading area. This has led to the cryptocurrency being traded in futures contracts, and the different kinds of derivatives products that come with it.
Understanding this new trading landscape is important to a new Bitcoin trader as there are similarities, but also key differences, that can suit some traders better than others. With that in mind, keep reading to understand the boom of Bitcoin derivatives trading and what the differences are between Perpetual swaps, Futures, and other types of contracts.
A recently conducted survey has shown that spot trading is still the biggest area for crypto traders, but that share is falling. According to the survey, 53 percent of traders are spot traders, while 47 percent are derivatives traders. This number has grown significantly as more platforms and services have been offered.
One of the more popular ways to trade Bitcoin nowadays is through futures contracts. These are contracts that allow investors to make an agreement to buy and sell Bitcoin at a predetermined price, and at a specific time. This is a trading method that is common across a number of assets and commodities.
Bitcoin works in this type of trading because of its well-known volatility. The contract is made at a predetermined price that is expected to be quite different when the expiration date arrives. In a futures contract, the buyer and the seller must adhere to the terms of the contract regardless of the new market conditions.
One can start to see why this would be an exciting option for traders as this means they can use futures contracts for both hedging against a falling market, or for bigger trade speculation. Using it for hedging or speculation depends on which way the market will move.
For example, if Bitcoin is valued at $10,000 a coin and a futures contract is made for a month, that means in a month, the seller will sell that coin for $10,000, and the buyer will buy it at that price. Now, if the price of the coin goes down, the seller has hedged his bet and still makes a profit. This is taking a short position.
A trader can also take a long position if they think the price will rise and try and capitalize on the upward trend by entering a contract to buy the $10,000 Bitcoin at the end of the contract when the price has gone up.
There are different types of trades that fall under the umbrella term of derivatives and it is important to understand the subtle differences. Bitcoin traders may be familiar with both Bitcoin Futures Options, and Bitcoin Perpetual Swaps.
Bitcoin Perpetual Swaps operate in the same way as a Bitcoin futures contract except that there is no set expiry date for the end of the contract. Usually, there will be a time period like a month when the contract has to be honored, but in a perpetual swap, the contract can go on indefinitely.
Perpetual Swaps also mimic a margin-based spot market and hence trade close to the underlying reference Index Price. These changes also mean that the trader has to be aware of different mechanics that come into play when using Perpetual Swaps. Some examples of these mechanisms include position marking, because these contracts are marked according to the Fair Price Marking method (which helps stop unnecessary liquidation)
In a Perpetual Swap, a trader is again choosing to long or short, but there are also the funding fees. This is a mechanism that ensures convergence of the perpetual price to the spot price by an exchange of currency swaps between traders in long and short positions. These are often paid every eight hours.
This is where payment can occur because if the funding rate is positive, then long positions will pay, and short positions will receive the funding. If the rate is negative, it works the other way round.
There are also Bitcoin futures options to consider when delving into derivatives trading. These have also become increasingly popular on traditional trading platforms that have incorporated Bitcoin like Chicago Mercantile Exchange (CME).
An “option” is a type of derivative contract that gives the owner the option (not the obligation) to buy or sell an asset at a specified price (the strike price) within a predetermined time (the expiry date). This makes the futures contract more flexible.
These options open the door for users in the market to generate income, make more speculative bets on the market, and hedge positions and are especially valuable in Bitcoin because of its high volatility.
In an option contract, there is a “writer,” or seller, of the option and a buyer. The buyer pays a premium for the options contract determined by factors including moneyness (the asset’s current price vs. the strike price), time to expiry, and implied volatility. The writer then takes that premium as income.
This entry of Bitcoin into traditional trading areas of derivatives trading is a major step for the asset as it further legitimizes and normalizes it along the same lines as gold or oil. More so, the fact that CME and Bakkt, as well as crypto exchanges like PrimeXBT, Virtuse, and others offer all of these choices in one place, shows the popularity in adoption of this new asset class.
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