- Crypto derivatives are financial instruments that allow traders to buy or sell cryptocurrencies for a predetermined price at some point in the future.
- These instruments are called derivatives because they “derive” their value from the underlying crypto asset.
- Large exchanges like Bybit, Deribit, and Bit.com support a wide range of crypto derivatives markets.
What Are Crypto Derivatives, Exactly?
You probably already know what normal crypto trading is… You go to a trading exchange like Coinbase, you select what crypto you want to buy (Bitcoin, Ethereum, etc.), you pay for it, and the tokens show up in your wallet. Easy, right?
That type of trading is great if you want to actually own crypto — so that maybe you can buy a hot new NFT or send Ethereum to a friend — but what if you want to buy crypto just to make money by buying low and selling high? In this case, having to store your crypto in a wallet and paying gas fees is just unnecessary pain. What if there was a way to just buy and sell crypto without having to actually deal with the tokens themselves?
Well, that’s what crypto derivatives allow you to do. One way to think of crypto derivatives is like betting on a horse race. You place your bet on what horse you think will win, and, at some point in the future, when the race is over, you find out if you made money or lost money.
Crypto derivatives “derive” (hence the name) their value from the underlying cryptocurrency — so Bitcoin, Ethereum, Dogecoin, etc., each have their own derivatives markets. There are several types of crypto derivatives, including options, futures, and perpetuals, and we get into the nitty-gritty of each below. To get the GIST, though, all you need to know is that derivatives allow you to bet on the price of a cryptocurrency without having to actually own it.
At first, this may seem like a niche use-case, but derivatives actually make up the majority of crypto trading volume — usually more than 2x that of spot trading (agreeing to buy and sell crypto for a certain price and a specific time in the future.) Derivatives are a very important aspect of any financial market. They make sure there is enough money in the system to fill trades, and they help determine the correct market price of assets like cryptocurrencies.
Are you more of a numbers person? Check out our example (with the math provided) in the dropdown below.
Crypto Derivatives Example
Let’s look at an example of how trading a crypto call option would work.
You purchase a Bitcoin call option for $1,000 with a strike price of $20,000 and an expiration date of March 4th, which, in this example, is six months in the future. This means that you pay $1,000 upfront for the right to buy Bitcoin for $20,000, on March 4th, regardless of how much Bitcoin is actually trading for that day.
Over the next six months, the crypto markets start pumping, and by the time March 4th rolls around, Bitcoin is trading for $30,000. Your call option allows you to purchase Bitcoin at $20,000. So you exercise your option to purchase 1 BTC for $20,000 and then you immediately turn around and sell it on the open market for $30,000. Your profit from this sale is $10,000. You net $9,000 overall for this trade after deducting the $1,000 you initially paid for the option.
This strategy is different from simply purchasing and holding Bitcoin because the option gives you the right, but not the obligation, to buy Bitcoin. This means that had the market gone down instead of up and Bitcoin was trading for less than your strike price, you would not exercise the option, and you also would not be stuck holding BTC that has now depreciated significantly.
Pros And Cons Of Crypto Derivatives
- Bet on crypto prices without having to deal with gas fees and crypto wallets
- Trade using lots of leverage — from 10x all the way up to 100x
- Derivatives have sometimes been called “portfolio insurance” as they allow you to hedge your other bets
- Due to strict regulations, derivatives trading is not available to retail traders in the US
- Derivatives can be difficult to grasp for beginners and may be dangerous to trade if you don’t have a good understanding of what you’re doing
- Most exchanges only offer derivatives for the most popular cryptocurrencies like Bitcoin, Ethereum, and Solana
Who Should Trade Crypto Derivatives?
Crypto derivatives are a major part of the crypto trading market. Here are some examples of who should trade crypto derivatives:
- People who want to hedge their holdings: If you buy a bunch of Ethereum that you plan to hold for a while, you may want to hedge your holdings by buying an option that allows you to sell your Ethereum for a set price at some point in the future. This way, if Ethereum plunges in value, you’re covered.
- More advanced traders: Derivatives trading is not for the faint of heart or for crypto beginners. Futures, for example, require you to sell or buy a cryptocurrency at some point in the future, so you must be able to fulfill that obligation.
- People who want to use leverage: Leverage allows you to 10x or 100x your trade by taking out a loan that magnifies your position. For example, if you have $100 that you want to use to trade, you can use 10x leverage to make that into a $1,000 trade. Leverage trading can be very profitable, however, it can wipe you out instantly if the market doesn’t go your way.
How To Trade Crypto Derivatives In 4 Steps
Step 1: Pick a Derivatives Exchange.
Derivatives exchanges such as Bybit, Deribit, and Bit.com offer derivatives markets for several large cryptocurrencies, including Bitcoin, Ethereum, Solana, and Bitcoin Cash. To get started, sign up for one of these platforms and fund your account using a crypto wallet, a credit card, or your bank account. Not sure which exchange to pick? Don’t worry, we’ll cover this in a bit.
Step 2: Choose The Type Of Derivative You’d Like To Trade.
The most popular type of derivative is a perpetual future — which trades at the same price as the underlying token (Bitcoin or Ethereum) and allows you to buy low and sell high without actually having to store the token in a wallet and paying gas fees. On derivatives exchanges, you will be able to pick between perpetual futures, normal futures, and options to purchase. We cover the differences between these below.
Step 3: Complete Your Purchase.
Crypto derivatives are usually cheaper than buying the actual crypto asset. Determine how much you’d like to invest in your derivative asset of choice and complete your purchase.
Step 4: Monitor Your Obligation.
If you purchase options or futures, you may have some additional obligations. For example, purchasing Bitcoin futures requires you to purchase actual Bitcoin at some point in the future, so you need to keep this in mind and track the expiration date of your futures contract.
Types Of Derivatives
There are several types of derivatives — options, futures, and perpetuals. Each has different rules and serves a different purpose.
An option gives you the right to buy or sell a crypto (like Bitcoin) for a predetermined price at some point in the future.
Options are the most basic form of derivative. An “option” is a derivative that gives you the right, but not the obligation, to buy or sell a cryptocurrency at some point in the future. An option that gives you the right to buy a cryptocurrency in the future is known as a “call” option, while an option that gives you the right to sell a cryptocurrency is a “put” option. Buyers and sellers agree on the price that the crypto will be bought or sold, known as the “strike” price.
Want to learn more? Check out our guide to crypto options.
Futures are similar to options, but unlike options, which give the owner the right but not the obligation to exercise the option, futures must always be exercised (you’re obligated) on the expiration date.
Futures are very similar to options in their basic setup — they’re an agreement to sell or purchase crypto at some point in the future. However, unlike options which merely give you the “option” of using them, futures require you to exercise them. This means if you purchase a future on Ethereum, you are required to buy ETH on the expiration date for the strike price, regardless of what ETH is actually trading at on that day.
A perpetual contract is simply a futures contract with no expiration date.
While futures and options have expiration dates that determine when an asset can be purchased or sold, perpetuals do not have expiration dates and are trading back and forth constantly. Perpetual futures are the most common type of derivative, and they allow traders to speculate on price movements without actually having to buy, sell, or store the underlying crypto assets.
Want to learn more? Check out our guide on crypto perpetuals.
Crypto Derivatives Exchanges
|Exchange||Assets||Fees||Minimum Order Size|
|Bybit||BTC, ETH, SOL||Maker Fees: Starting at 0.03% of the underlying asset value|
Taker Fees: Starting at 0.03% of the underlying asset value
|Deribit||BTC, ETH, SOL||Maker Fees: Starting at 0.03% of the underlying asset value|
Taker Fees: Starting at 0.03% of the underlying asset value
|BTC options: 0.1 BTC|
ETH options: 1 ETH
|Bit.com||BTC, ETH, BCH||Maker Fees: Starting at 0.02% of the underlying asset value|
Taker Fees: Starting at 0.05% of the underlying asset value
Delivery Fees: 0.015% for all options except those with daily expiration dates
|0.01 BTC for USD-margined options|
0.1 BTC, 1 ETH, or 1 BCH for token-margined options
Bybit is one of the world’s largest cryptocurrency exchanges by trading volume. It’s most commonly used to trade crypto options, futures, and perpetual derivatives. Bybit supports derivatives for Bitcoin, Ethereum, and even Solana, which is only supported by some derivatives exchanges.
Compared to other exchanges, Bybit features low trading fees (starting at 0.03% of the underlying asset value per trade) and up to 100x leverage, which is more than most exchanges offer. On the downside, Bybit is not available in the US, and there are limited trading pairs since only three cryptocurrency derivatives are supported.
Deribit is the largest crypto derivatives exchange by trading volume. The exchange has relatively low fees (starting at 0.03% of the underlying asset value per trade) compared to other exchanges and supports Bitcoin, Ethereum, and Solana derivatives. Deribit’s interface allows traders to pick out options from a selection of expiration dates and strike prices — the price that the option expires at — that revolve around the current trading price of the cryptocurrency.
Deribit also has an insurance fund of several million dollars that’s used to cover unexpected losses, which is a feature that only the largest derivatives exchanges provide. Deribit is not available in the US, and accounts can only be funded with Bitcoin, which is unusual compared to other exchanges.
Bit.com is a popular derivatives exchange that supports Bitcoin, Ethereum, and Bitcoin Cash derivatives. The exchange separates derivatives trades into USD-M and Coin-M markets. The former is settled in USD, while the latter is in the underlying cryptocurrency (Bitcoin, for example).
Bit.com offers 10x leverage, which is less than the 100x leverage offered by exchanges like Deribit. Bit.com also features low fees starting at 0.02% of the underlying asset’s price and supports Bitcoin Cash derivatives, which are not supported by many other exchanges.
Why Trade Crypto Derivatives?
Crypto derivatives can be used for a variety of purposes, including hedging your bets and buying low/selling high without having to actually transfer any crypto assets.
Hedging is a strategy you can use to limit losses in the case a trade you made does not go the way you expect.
For example, if you purchase a large amount of Bitcoin, expecting the price to go up, and it goes down instead, you may be left with significant losses. To mitigate the downside in this scenario, you can take out a “put” option, which allows you to sell Bitcoin at a predetermined price at some point in the future, regardless of how low it’s trading. This way, if Bitcoin goes up, you will benefit from your initial Bitcoin investment, and if it goes down, you will limit your losses by exercising your put option.
Going “short” is making a bet that an asset will go down in price rather than up.
Traditionally, shorting is done by borrowing an asset, such as Bitcoin, selling it, and then purchasing it later when the price is lower. You return it to the lender to satisfy your debt while pocketing the difference in price. You can also short by using options. If you purchase a Bitcoin put option, for example, you are betting that Bitcoin will go down. If it does go down in price, you can exercise your put option to sell Bitcoin for higher than it is trading on the open market and make money in the process.
Trade Without Holding Assets
Derivatives allow you to buy low and sell high without having to actually transfer and store cryptocurrencies.
Perpetual futures are the most commonly traded crypto derivative by far. This is because they allow investors to get all the benefits of trading cryptocurrencies without having to worry about actually exchanging assets, storing the crypto in wallets, and paying gas fees. Perpetual futures prices closely track the prices of the underlying assets, so if you’re looking to price speculate without dealing with the crypto itself, perpetual futures allow you to do just that.
To Sum It Up
Derivatives can definitely be a lot to take in. Once you get the hang of them though, they open up a whole world of possibilities that allow you to trade more easily, hedge your bets, and do all sorts of trading wizardry that’s not normally possible.
Be careful, though, derivatives are the “dark arts” of trading, and they’ve bankrupted countless naive traders before. Proceed with caution.
Frequently Asked Questions
Derivatives are safe if handled correctly, yes.
While derivatives are more complex than traditional spot trading, they are completely legitimate instruments that are also present in the traditional stock market. Keep in mind, however, that derivatives can be dangerous to trade if you’re overleveraged or if you do not have the necessary grasp of the complexity of the instruments.
Crypto exchanges differ in what cryptocurrencies they support, what fees they charge, and what services they provide.
For that reason, it’s difficult to determine the best derivatives exchange for any given individual. However, Bybit, Deribit, and Bit.com are all vetted and legitimate exchanges, so any of these would be a good place to start.
Spot trading is when you buy or sell a cryptocurrency and transfer the cryptocurrency between the buyer and seller.
Derivatives trading, on the other hand, is trading instruments that derive their value from an underlying cryptocurrency. These trades usually do not involve the actual transfer of the underlying cryptocurrencies (although they can) and are often used to hedge positions or for price speculation.
The trading volume of the crypto derivatives market is massive. Even during July 2022, in the depths of the crypto bear market, derivatives volume was over $3 trillion for just that month.
Coinbase is piloting a derivatives marketplace for clients of several major brokerages.
Derivatives trading is not yet available to all Coinbase traders. However, the company is pursuing a license from regulators to be able to operate as a futures commission merchant and make derivatives available to everyone on the platform.
Many crypto derivatives exchanges do not offer their services to customers in the US due to the country’s stringent financial regulations.
When it comes to taxes, your profits from trading derivatives are taxed as capital gains — the same way your regular crypto earnings would be taxed. Since options and futures are transactions that happen across a span of time, profits for these derivatives are determined after the expiration date, and taxes are calculated accordingly.