Derivatives are gaining grounds lately in the crypto industry, though they are the oldest form of financial contracts. A derivative is a document of a financial contract between two parties based on the future price of a particular asset. The contract can be signed by two or more persons wishing to buy or sell a particular asset for a specified future price. The value will be determined based on the changes in the value of the underlying asset.
Financial derivatives are those assets used in financial contracts which include stocks, bonds, commodities, fiat currencies, cryptocurrencies, market indexes, and interest rates. They can be traded on exchanges or from person to person depending on the terms of the contract.
Derivatives have grown to become one of the most popular financial mechanisms. The evolvement of the crypto industry has helped to facilitate the development of these tools. Players from both privately funded investment funds and public exchanges are gearing towards the launch of cryptocurrency derivatives.
According to a report by a bitcoin trading platform, LedgerX, it recorded about seven times increase within six months of crypto derivatives. It secured about 176 contracts being traded within the first week of trading, which has increased by 40% every month. LedgerX has about 2,000 open-interest contracts on its trading platform since it introduced its first long-term bitcoin futures option in November.
How Do Derivatives Impact The Crypto Industry?
The development of derivatives may look like it’s a parrel market but it directly affects the crypto industry in some ways. It can boost liquidity as well as trading volumes of the digital assets. Derivatives do not have direct value on their own but draw on the changes or movement in the future prices of the underlying cryptocurrency. It is used as hedge funds by investors to protect themselves from price fluctuations, signing a contract to buy an asset at the future price will help mitigate the risk that may arise. The application of derivatives allows the manipulation of crypto prices despite market development.
Since 2017, there has been an increase in the number of people that invest in derivatives. The most popular is the bitcoin futures, bitcoin is less volatile than other cryptos, it has been able to maintain a steady upward movement for the past years. Bitcoin derivatives are valuable and can be used to serve various purposes such as hedging position, speculation on prices, determine future risks and gain positions in the bitcoin market.
Manipulation In Crypto Prices
Derivatives are used to speculate on the price of an underlying asset. Traders can predict what changes will be on the price of a given asset in the future. Due to forecasts, most times the crypto price does not tend to move according to the market developments because it drives on predictions. High prognostications will enable more earning on the financial contracts, thereby creating room for manipulation by dubious minds who will purposely hike asset prices.
Some analysts believe that derivatives create challenges that impact negatively on the crypto market and prices.
According to an analyst, Dave Kranzler of Investment Research Dynamics, derivatives can be used to manipulate crypto prices when a specified amount of fiat-dollar-based crypto contract papers are issued with a few investors buying into the contract. This will cause prices to shoot up, even if there is a favorable market condition.
It Pushes Volatility To A Greater Extent
Crypto infrastructure is still at the developmental stage, there will be an increased awareness of the cryptocurrency industry as the infrastructure gains exposure. Bitcoin has been evaluated to have ten times a change in price than the US Dollar in a short period. This makes it difficult to determine the future value of the crypto assets or being held as a store of value. Derivatives allow large-volume traders to influence the prices of crypto assets since this is the major way they can exchange the value to fiat.
It Undermines Positive Market Development
Manipulation of prices via speculations can create a bearish market even when there is positivity in market development. Large volume traders like the bitcoin Whales can move the crypto prices as they want even when the market is favorable to achieve a particular aim. All they need is a large chunk of transactions to stir up the price trend.
However, derivatives may not affect the underlying asset prices in the long run. When a large value of financial contracts is issued above the demand, the prices will drop which will also affect the price of the underlying asset.
Crypto derivatives may have a controlled impact on the general crypto sphere, however, it has facilitated infrastructural development and awareness. It encourages investment in digital currencies and offers investors the best option to mitigate inherent risks. Despite its challenges, investors have seen it as a more secure way to trade cryptocurrency.