The beginning of derivatives trading signals the maturity and mainstream acceptance of any asset. The derivatives are designed for the more sophisticated traders and investors. Below are the main reasons why crypto derivatives will continue to rise in 2021 and beyond:
- Derivatives are used to hedge cryptocurrency volatility risk
The main reason for traders to invest in derivatives trading is to mitigate the risks associated with the volatile nature of cryptocurrencies. 2021 has been the year of mainstream acceptance of cryptocurrencies. However, since cryptos are inherently volatile, derivatives give merchants the option to hedge against such risks. For example, if you anticipate that BTC will become volatile, you can use inverse BTC/USD futures to lock in a specific value.
- The increased regulation of the crypto sector has increased the appetite for crypto derivatives
The increased regulation of the crypto ecosystem is seen as a sign of acceptance by governments and financial authorities of cryptocurrencies as a distinct asset class. This has led to public corporations, hedge funds, and high net-worth individuals entering the market in search of superior returns. 2020 saw the most regulation enacted around cryptocurrencies, which coincided with the highest number of corporate traders in crypto derivatives. Such traders seeking superior returns often prefer crypto derivatives since they allow leveraged trading, which significantly magnifies profits.
3. Crypto Derivatives bring liquidity into the market
Trading in crypto derivatives means that you do not need to own the underlying coins, so you can easily enter and exit a trade. There are finite cryptocurrencies in the market. For example, there is a little more than 17 million BTC in circulation as of this publication. This would mean that BTC is illiquid in the spot market, which means it is susceptible to price volatility. However, with derivatives, market makers can easily manage their exposure by providing liquidity and hedging their risks in the spot market, freeing up liquidity for the underlying crypto.
4. Derivatives will play an important role in the price discovery of cryptos
For any asset, the price is often determined by supply and demand. In the past, since trading only took place in the spot market, price discovery in the crypto market was inefficient. In the spot market, traders and investors participate in trading in anticipation of cryptos appreciating in value. With derivatives, traders can take either a long or short position. This ability, along with increased liquidity, ensures a more efficient price discovery process. In turn, efficiency in price discovery helps legitimize cryptocurrencies as tradable assets.
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