Here's What You Should Know About Trading Bitcoin Derivatives
Scroll DownThe cryptocurrency markets have matured to the point of offering derivative instruments. A few years ago, the Chicago Mercantile Exchange made history when it launched Bitcoin futures; soon thereafter, major cryptocurrency exchanges started offering their own brand of derivatives that do not directly compete with the CME because they do not have to be purchased with U.S. dollars.
An easy way to understand cryptocurrency futures contracts and other financial derivatives is to look at the history of these instruments themselves. In the 16th century, Japanese rice merchants and the Dojima market created purchase and sell contracts that speculated on the future value of rice and other agricultural products. The idea was to derive economic advantage now; for example, a contract to purchase rice at a lower price today, but with a delivery date set at a higher price in the future, brings about immediate profit since the merchant will be able to sell higher.
Futures contracts are called derivatives because they are written on top of underlying commodities such as rice, gold, coffee, tea, frozen orange juice, and even pork bellies. At the CME, all Bitcoin futures contracts are written and settled in U.S. dollars. Traders do not actually acquire any Bitcoin; only the right to buy or sell tokens at some point in the future. In reality, most contracts either expire or are executed without traders taking delivery of the tokens; this happens because the nature of the derivatives market is highly speculative, and traders simply reinvest their profits to generate revenue.
Derivatives offered by cryptocurrency exchange platforms are created through ERC20 tokens. Most of the contracts are created via a "settled" token that is essentially a futures contract. Unlike futures at the CME, digital currency derivatives are more likely to result in traders taking delivery of tokens. Both CME and exchange-based derivatives are more likely to be traded based on technical analysis instead of fundamentals, but the difference is that traders of the former do not want to put any "skin in the game" because they are not interested in holding tokens; they just want to profit from fluctuations in the markets.
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