Derivatives Definition in Crypto

Derivatives are contracts whose value comes from something else, called the underlying asset. In crypto, the underlying is usually a coin or token such as Bitcoin or Ether. These contracts let people get exposure to price moves without holding the asset itself.

How derivatives work

A derivatives trade links two parties, a buyer and a seller, under agreed terms. The contract tracks the underlying asset’s market price, specifies how much the contract covers, and sets when and how it will settle. Settlement can involve actual delivery of the asset or a cash payout equal to its value.

Core pieces of a contract

• Underlying asset: the thing the contract references, like BTC or ETH.
• Contract size: how many units the contract represents.
• Settlement date: when obligations are due, unless it is a perpetual contract that has no expiry.
• Settlement method: physical delivery of the asset or cash settlement using fiat or stablecoins.

Why traders use them

Derivatives can help with several goals:

• Hedging, which offsets risk in a spot position.
• Speculate on going long or short on expected price moves.
• Access and flexibility to build strategies not possible with simple buy and hold.
• Gain leverage by controlling larger positions by posting margin, which can magnify your gains and losses.

Main types in crypto

Futures

A futures contract sets a price today for a trade at a future date. Traders can take long or short positions and close them before expiry by taking the opposite side. Losses and gains across all participants net out because futures are zero-sum.

Perpetual swaps

Perpetuals work like futures but do not expire. To keep the contract price close to spot, exchanges use a funding rate paid periodically between longs and shorts. If the perpetual trades above spot, longs usually pay shorts, and the reverse when it trades below.

Options

Options give the right, not the obligation, to buy or sell the underlying at a set price before or on a set date. In crypto, options provide flexible ways to structure protection or express views on volatility.

Settlement styles

• Physical delivery: the underlying asset changes hands at settlement.
• Cash settlement: parties exchange the cash or stablecoin value instead of the asset itself. Cash settlement is common in crypto markets.

Where they trade

Derivatives trade on centralized venues and on decentralized protocols. Centralized platforms match orders and handle margin, while decentralized platforms run contracts on blockchain rails. Both aim to provide access to futures, perpetuals, and options tied to digital assets.

Risks and considerations

Leverage amplifies results and can trigger liquidations when markets move fast. Perpetual funding payments add costs that can eat into returns. As with any contract, users should understand how settlement, margin, and fees work on the venue they choose.