What is a Derivative?
A derivative is a financial contract with a value that is derived from an underlying asset. Derivatives have no direct value in and of themselves — their value is based on the expected price movements of their underlying asset. When the underlying asset is a cryptocurrency like Bitcoin, they are termed as Cryptocurrency Derivatives. Trading Crypto derivatives doesn’t actually mean buying or selling cryptocurrencies. It provides an alternative path to get exposure to the underlying cryptocurrency.
Derivatives are often used as an instrument to manage financial risk at the expense of high returns for the other party.
There are mainly 4 types of Derivatives –
What are futures?
Futures are contracts that facilitate the buying or selling of an underlying asset at a predetermined price at a future point in time. Counterparties are obligated to fulfil the terms of the contract, either buying or selling the asset at the decided price on the date of expiry. There are special types of futures which come with no expiration date. These futures are called
What are Cryptocurrency Futures?
The contracts are still settled at the predetermined price.
Crypto futures allow you to speculatively trade on the future prices of cryptocurrencies without owning the cryptocurrencies. When two parties enter into a crypto futures contract, they agree to buy/sell an asset or security at a pre-fixed price on a selected date in the future. The price of Cryptocurrency futures is directly proportional to the prices of the underlying cryptocurrencies. Users of CoinDCX can trade both Bitcoin and Altcoin futures on the platform.
Leverage:
Traders can enter positions that are larger than their account balance
Futures vs Margin Trading:
Cryptocurrency Futures are always superior to margin trading because futures provide:
More leverage:
Future contracts allow much higher leverage than the maximum leverage allowed in Margin trading. On CoinDCX, Cryptocurrency futures can be leveraged to as high as 15x whereas margin trading is capped to 5x.
More liquidity:
Margin trading market is a borrowing market which are hard to build, and as a result, have lower liquidity. Future markets are more liquid than spot markets since they are free of this limitation and are easy to develop.
No Cost of Interest:
The futures contract will either trade at a premium or discount. There are no costs of interest involved in holding the futures. In the case of margin trading, CoinDCX offers interest-free margin trading for first 1 hour and charges 0.05% per day thereafter.
CoinDCX – India’s first Cryptocurrency derivative exchange
CoinDCX is India’s first cryptocurrency derivative exchange which offers immense liquidity on its Bitcoin and Altcoin future products. CoinDCX allows its users to trade cryptocurrency futures with up to 20x leverage. Maximum leverage limit for every futures contract can be found under the contract details section on the trading terminal.
Future Trading on CoinDCX –
CoinDCX has future trading on Bitcoin and 8 leading Altcoins. These are Ether (ETH), XRP (XRP), Bitcoin Cash (BCH), Litecoin (LTC), Eos (EOS), Cardano (ADA), and Tron (TRX). Users can also trade perpetual future contracts with Bitcoin and Ethereum perpetual futures.
Overview
Perpetual contracts are similar to futures but without any expiration date. However, the power to hold the contract forever comes at an expense. This expense is decided based on‘Funding’. Perpetual Contracts are marked according to the Last Price Marking method. The Last Price determines Unrealised PnL and liquidation prices.
Benefits of a perpetual contracts vs. futures
Since a futures contract has an expiry date, a trader looking to maintain his position will need to periodically roll to a next contract as the previous one expires. Perpetual contracts eliminate the need to roll positions. Perpetual contracts are an easy-to-go solution for regular traders.
The bases, i.e. the difference between the price of a futures and its underlying is higher compared to perpetuals. This exposes futures traders to basis risk.
Funding
Fundings are periodic payments exchanged between the buyer and seller every 8 hours. If the rate is positive, then longs will pay and shorts will receive the rate, and vice versa if the rate is negative. It brings the price of the perpetual contract back to the spot.
When the Funding Rate is positive (perpetual contract trades at a premium to spot), longs pay shorts. When it is negative (perpetual contract trades at discount to spot), shorts pay longs.
Note – You will only pay or receive funding if you hold a position at the Funding Timestamp.
Funding Timestamps: 09:30 IST, 17:30 IST and 1:30 IST.
Your position value is irrespective of leverage. For example, if you hold 100 BTC-USD contracts, funding is charged/received on the notional value of those contracts, and is not based on how much margin you have assigned to the position.
Funding Rate –
The Funding Rate is comprised of two main parts: the Interest Rate and the Premium / Discount. This rate aims to keep the traded price of the perpetual contract in line with the underlying reference price.
Interest Rate Component
Every contract consists of two instruments: a Base currency and a Quote currency. For example, on BTC-USD, the Base currency is BTC while the quote currency is USD. The Interest Rate is a function of interest rates between these two currencies:
Interest Rate (I) = (Interest Quote Index – Interest Base Index) / Funding Interval
where
Interest Base Index = The Interest Rate for borrowing the Base currency
Interest Quote Index = The Interest Rate for borrowing the Quote currency
Funding Interval = 3 (Since funding occurs every 8 hours)
Premium / Discount Component
The perpetual contract may trade at a significant premium or discount to the Last Price. In those situations, a Premium Index will be used to raise or lower the next Funding Rate to levels consistent with where the contract is trading. Each contract’s Premium Index is available on the specific instrument’s Contract Specifications page and is calculated as follows:
Note –
CoinDCX doesn’t charge any funding fees from its users. There is no interest rate on keeping the position open indefinitely in perpetuals. The payments are directly interchanged between the buyer and the seller.
PnL Calculation
In crypto derivatives, there are two types of PnLs, realized and unrealized. Particularly in perpetual contracts, When you have open positions and it is susceptible to change based on market conditions, we call the PnL is unrealized. When you close your positions, the unrealized PnL becomes realized PnL (either partially or entirely). Here we will discuss how the unrealized and realized PnLs are calculated:
Example 1, Buying and Selling
Perpetual Contracts
Suppose you are long 1,000 BTC-USD contracts with an average entry price of $1,000. The last price of BTC-USD is currently $1,250.
Your unrealised PnL is based on the difference between his average entry price and the current price.
Unrealised Profit = ($1/$1,000 – $1/$1,250) * 1,000 = 0.20 BTC
Now, the last price of BTC-USD is $1,500.
You decide to sell 500 BTCUSD contracts at $1,500 and realise some profit.
Your realised PnL is based on the difference between his average entry price and the price at which you sell BTC-USD contracts.
Realised Profit = ($1/1,000 – $1/$1,500) * 500 = 0.17 BTC
Realised PNL is based on where you can actually buy or sell your position, which in most cases is not the mark price. If Ram had sold his 500 contracts at the lost price of $1,250, he would have a realised profit of 0.10 BTC.
Example 2, Funding Fees
Suppose you are trading a BTC-USD perpetual contract. Every 8 hours, there is a funding fee. The funding fee is currently 1%, and is paid from buyers to sellers.
You currently long 100 BTC worth of BTC-USD contracts. The position has no realised PnL. It is funding time and you must pay 1 BTC (1% of 100BTC) to the seller. After the funding fee has been paid, your realised PnL is now -1 BTC.
If you are short 100 BTC worth of BTC-USD contracts instead,you will receive 1 BTC (from the buyer of your 100BTC). Your realised PnL will then be 1 BTC.
Examples
Long BTCUSD Perpetual Contract Example
The following examples do not take Premium into consideration.
Perpetual Contracts
Realised Profit = ($1/1,000 – $1/$1,500) * 500 = 0.17 BTC
Margin Currency = Bitcoin
Underlying Index = BTC OKEx Indices
Interest Quote Index = USD Lending Rate in the OKEx Indices (.USDBON)
Interest Base Index = BTC Lending Rate in the OKEx Indices (.BTCBON)
Funding Timestamp = 02:00 UTC, 10:00 UTC, and 18:00 UTC
Day 1, 08:00 UTC
You go Long on 150,000 BTC-USD Perpetual Contracts at a price of 7500 USD.
BTC Position Value = 150,000 Contracts * 1 USD * 1/7500 = 20 BTC
Day 1, 10:00 UTC
You hold the position over the Funding Timestamp at 10:00 UTC+00 and exchange the Funding Amount. The amount you pay is determined as below:
The BTCUSD spot price is currently 7500 USD.
Interest Quote Index = 1.00% per day
Interest Base Index = 0.25% per day
Funding Rate = (1.00% – 0.25%) / 3 = 0.25%
Funding Amount = Position Value * Funding Rate = 20 BTC * 0.25% = 0.05 BTC
The Funding Amount is positive, so you need to pay since you are Long, and your counterpart who is Short receives this 0.05 BTC.
Day 1, 16:00 UTC
The BTCUSD contract rises in price to 8000 USD. You close your position by selling the 150,000 BTCUSD contracts. Since you do this before the next Funding Timestamp at 18:00 UTC+00, you do not need to pay the Funding Amount at that time.
You made 1.25 BTC profit from the increase in the value of BTCUSD: PnL = 150,000 * 1 USD * (1/7500 – 1/8000) = 1.25 BTC
You exchanged 0.05 BTC in funding, and your total profit is 1.2 BTC (1.25 BTC – 0.05 BTC).