What Is a Derivative?

Derivative

A financial instrument deriving its value from the value of an underlying asset.

What Is a Derivative?

Derivatives are extremely common and popular financial instruments. They are often used for risk hedging. If an investor knows that they want to buy an asset, they may sign a derivatives contract agreeing to buy the asset at a specific price. This helps them to hedge against potential fluctuations in the value of the asset.

However, derivatives markets are also very popular as a subject of speculation. Instead of ever owning the asset in question, traders simply bet on its future value. The explosion of derivatives, particularly those based on mortgage lending, was the key driver behind the financial crisis.

But derivatives still have uses, and they are becoming increasingly common in crypto.

Crypto derivatives can, of course, be used as a means for speculators to make profit, just like derivatives based on fiat currencies. But the risk hedging aspect is possibly the most important long-term advantage of the arrival of crypto derivatives.

A key example of this was the mass launch of Bitcoin futures in 2017. Many in the crypto community believe that in order to achieve mass adoption as a store of value, Bitcoin needs to offer investors a way of mitigating risk.

Wild price fluctuations are a chance for speculators to make money, but they are also offputting to more risk-averse investors. The launch of Bitcoin futures on the Chicago Board Options Exchange was seen as a big milestone for Bitcoin as it offered institutional investors a way to hedge against those fluctuations.

Crypto derivatives are widely available on most major crypto exchanges. There are also moves towards the expansion of derivatives offerings from traditional global exchanges such as the Nasdaq.

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