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Any financial instrument whose value is anchored to another asset or basket of assets, which is called the 'underlying asset', is known as a derivative. In this way, the product closely monitors price changes of the underlying asset with the aim of allowing traders to speculate and gain indirect exposure.
Like other products traded in the financial market, derivatives function as multi-party monetary contracts that can be used to trade, exchange, or settle. The main idea is that, through this contract, buyers can generate future income with changes in the price of the underlying asset and sellers receive liabilities for their marketing. An important point to know is that derivatives can be created with any type of asset, be it bonds, cash, precious metals and even other derivatives. In this sense, the cryptocurrency market has not been left behind and more and more financial products have been created that allow indirect exposure to the price of Bitcoin. The proliferation of exchange-traded funds, futures, and options contracts for Bitcoin is becoming increasingly noticeable in the institutional market.
Derivatives based on cryptocurrencies do not differ in operation from other derivatives in the market, beyond the fact that the underlying security that they replicate is a cryptographic asset. The product uses the bitcoin price, for example, as a benchmark and emulates it in its own market so that traders can benefit from the volatility of the asset.
However, derivatives may have slightly different prices than the international cryptocurrency market, despite the fact that their behavior is emulated. This is because the derivative is a financial product itself and traders make a series of offers and requests in the market for this product, affecting its price. In this sense, each derivative has its own mechanisms to maintain a certain parity with the underlying asset.
Exchange-traded funds, as their name suggests, are funds created from an asset or basket of assets that can be bought and sold just like a stock. ETFs can work on a single asset basis, such as Bitcoin, or diversify investing by allowing exposure to bonds, company stocks, and other crypto assets.
ETFs are similar in operation to a mutual fund in that they allow a trader to invest in a crypto asset without having to directly purchase and manage it. Users do not acquire Bitcoins, but shares in a fund that owns and holds bitcoins. Due to these characteristics, many institutional investors are interested in trading with this type of asset, since they can benefit from the variations in the price of the cryptocurrency without having to deal with its technical operation and the taxation is more defined.
Like other derivatives, ETFs work by tracking the price of bitcoin or currencies like ethers, then replicating them in their own market. Likewise, it is a product regulated by the financial authorities, as it is an instrument that is marketed in traditional markets.
To understand what a futures contract is, it can be defined as a derivative product that allows traders to speculate on the future price of an asset. It is a legal agreement between a buyer and issuer to settle a commercial transaction of a certain date. These contracts can be made with assets of any type, but in the case of bitcoin cryptocurrencies it is one of the most traded values. Bitcoin futures contracts began to be traded in 2012, growing in demand in 2014 with the incorporation of this product in markets such as the CME Group. In this sense, they are one of the types of derivatives that have been most used in the cryptocurrency market for trading.
Traders agree how the contract will be settled, the future price of the asset is defined, and on what date it will expire. It is important to note that this expiration date determines the last day on which you can practice trading with said contract; upon expiration, the trader charges the last traded price for the asset.
Perpetual futures contracts are another type of derivative created to speculate on the price of an asset over time. These are very similar to futures contracts in several ways, such as the fact that the underlying asset traded is held by one party while exposure to its price changes is gained.
However, one of its most notable differences is that these contracts do not have an expiration date and traders can maintain their position for as long as they wish. Simply put, these contracts do not expire and therefore users can continue to use them and speculate on the price of the underlying asset without worrying about the contract being liquidated.
In this sense, perpetual futures contracts work similarly to the cryptocurrency spot market. Traders do not use it to buy crypto assets at a cheaper price in the future, but rather to be able to take advantage of their market volatility without having to directly acquire and manage these assets. Since this is their business objective, such financial instruments need to have a price behavior very similar to that of the market of the underlying asset that they replicate. To avoid a disparity with currencies like Bitcoin or Ether, these contracts implement a funding rate that keeps them tied to the actual price.
An option contract is a financial product that gives traders the right, but not the obligation, to buy or sell an asset in the future at a specified price. In other words, the merchant has the possibility of choosing if he wants to buy a cryptocurrency in the future, or if he rather cancels the operation because it does not favor him.
These derivatives are divided into two types: call or 'buy' options, which bet that the price of the product will increase; and put or 'sell' options, where traders anticipate that the price will fall. Also, some traders may decide to buy both to bet that the price of the underlying asset will remain stable.
Option contracts are made up of several elements. For example, they have a premium, which is the price at which the options contract trades and changes as the expiration date approaches. Buyers purchase said contract at that value, paying sellers to open a position in the market. In addition, these products have a strike price, which is the price at which the underlying asset will be purchased when the contract is settled. If the strike price of the contract is lower than that of the underlying asset, then the buyer can purchase the asset at a discount. However, if the price is higher, the buyer has the option to void the transaction and only pay the seller the seller's premium.
For example, a person can open a call position for Bitcoin, which will be liquidated within a month, betting that the asset will rise in price. Over the course of this period, if Bitcoin enters a bull market, the trader should simply wait for the contract to settle and buy these Bitcoins at their past price. However, if the opposite occurs and the price decreases in the same period, then he has the possibility of canceling the contract and paying only the premium.