Why Derivatives Matter: 5 Key Factors for Cryptocurrency Adoption
While exploring cryptocurrency, there’s a high probability you have heard the term “derivatives” but wondering how it contributes to the wide adoption of crypto. In this article, we will explain what crypto derivatives are and give five major reasons they contribute to crypto adoption.
What are derivatives
Derivatives are a tradable financial instrument whose value is derived from one or more underlying assets. Essentially, a crypto derivative acts as a contract between two or more parties, hinging upon the specified crypto asset(s). The value of these assets is determined by fluctuations in the underlying asset itself, including crypto, stocks, bonds, commodities, interest rates, and market indexes.
Traditionally, Derivatives can be traded either over-the-counter (OTC) or on an exchange. Over time, derivatives have evolved to encompass a wide range of transactions and serve various purposes. In fact, derivatives now extend to include innovative forms tied to crypto assets, such as Bitcoin, Ethereum, Dogecoin, and more.
The versatility of derivatives enables their utilization in risk management, speculation, and leveraging positions. The derivatives market continues to flourish, offering an extensive array of products to cater to diverse needs and risk tolerances. These derivative products can be classified into “lock” and “option.” Lock products encompass futures, forwards, and swaps, the prevalent types of derivatives.
5 Key Factors for Cryptocurrency Adoption
Spot trading is like holding onto the actual assets, pretty straightforward. On the flip side, derivatives are a bit more complex but offer a ton of flexibility in navigating the markets.
Now, when it comes to derivatives, they open up a whole world of diverse trading strategies. Take crypto futures, for example. Traders can put together a basic game plan by buying and selling futures to capture interest from the difference between spot and future prices. It’s like strategic chess in the market.
And why does this matter? Well, it’s like adding variety to the industry mix. With all these different price options, the market grows up a bit, and gets more mature. Here are five ways derivatives boost crypto adoption.
- Derivatives might interest regular investors
The big shots in finance are getting into crypto derivatives because they offer a chance at consistent returns, similar to what you’d expect from fixed-income investments. They’re not just winging it — these big players are using fancy strategies like bull call spreads and covered calls to make their moves.
What’s interesting is that by mixing call and putting options, these financial bigwigs can be cautious and set limits on their risks without worrying about getting wiped out in the unpredictable world of options trading. That safety net is like a magnet, drawing heavy hitters from traditional finance and plunging them into the thrilling chaos of the crypto scene.
2. Higher capital efficiency
Margin trading enables traders to efficiently distribute capital across various markets and products by holding positions. When employed judiciously, this strategy facilitates diversification into multiple assets while maintaining a consistent risk profile.
This is achieved by committing only a fraction of the portfolio to enter a position. Additionally, derivatives, such as futures, offer an avenue to trade short, allowing traders to hedge potential risks against their inherently long spot holdings, thus enhancing overall risk management.
3. Bitcoin‘s use as collateral
Some companies want to stay away from the uncertainties of Bitcoin and other cryptocurrencies. They might like the idea of getting higher returns in the crypto world compared to regular fixed income. Big businesses that don’t want to deal with Bitcoin’s ups and downs but still want to grow their money can use borrowing and lending.
Take, for instance, the collaboration between Fidelity Digital Assets and the crypto borrowing and exchange platform Nexo. They’re working together to offer borrowing services for big investors. These investors can get cash loans using their Bitcoin as a guarantee. And the cool part is, they can use this borrowed money in the usual financial markets they’re used to.
4. Tax efficiency
In certain regions, engaging in derivatives trading comes with tax advantages. Take the United States, for instance — here, 60% of profits from derivatives contracts receive the favorable tax treatment of long-term capital gains, irrespective of the contract’s duration. This unique taxation approach adds allure to derivatives as a trading tool for individuals in this area. Moreover, it facilitates an accessible entry point for institutional investors to explore crypto derivatives, thereby propelling the sector forward.
5. Flexibility
Crypto Derivatives contracts offer traders greater flexibility in their trading strategies. For example, traders can easily take short positions on assets they expect to decrease in value, which is more challenging in spot or margin trading. This flexibility also enables the execution of scalping strategies, which are less effective or efficient in the spot market.
Wrapping Up
As the global crypto markets evolve, so does the digital asset derivatives market. Perpetual swaps have gained popularity among crypto traders, and the futures and options markets have also experienced consistent growth. This indicates a growing demand for derivative contracts within the emerging digital asset class.
Derivatives make it easy for people to join the crypto world without dealing with the complications of actually owning and securing crypto assets. When big institutional investors put money into this area, it not only makes the crypto industry bigger but also helps it last longer. Institutional investments provide the necessary capital for promising projects to mature and contribute to the overall development and maturation of the industry.
Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.
