A derivative is a contract whose value comes from the price of something else. In crypto, that something is usually Bitcoin, Ether or another token. Derivatives let traders bet on price moves in either direction, hedge coins they already own and take positions larger than their capital through leverage. Trading volume in crypto derivatives is larger than spot volume, and most of it is in one product: the perpetual contract.
This article covers the three main types, how margin and liquidation work, and the risks.
Futures
A futures contract is an agreement to buy or sell an asset at a set price on a set date. Suppose you buy a one-month Bitcoin future at 60,000 dollars. If Bitcoin is at 65,000 at expiry, you gain 5,000 per coin. If it is at 55,000, you lose 5,000. Both sides are bound by the contract. The SEC's investor education site has a plain definition of a futures contract.
Most crypto futures are cash-settled, meaning only the profit or loss changes hands, in dollars or stablecoins. CME Group launched cash-settled Bitcoin futures in December 2017 and Ether futures in 2021. These are the main regulated futures used by institutions in the United States.
Options
An option gives its buyer the right, but not the obligation, to buy or sell an asset at a fixed price, called the strike, on or before a set date.
- Call option: the right to buy. It gains value when the price rises above the strike.
- Put option: the right to sell. It gains value when the price falls below the strike.
The buyer pays a premium up front. That premium is the most the buyer can lose. If the market moves the wrong way, the buyer lets the option expire.
The seller is in the opposite position. The seller collects the premium and takes on the obligation. A seller of a call with no offsetting position has, in theory, unlimited loss if the price keeps rising. Option prices depend on the distance to the strike, the time left and expected volatility, so an option can lose value even when the price moves in the buyer's favor, if the move is too slow or too small.
Deribit has long been the largest venue for crypto options.
Perpetual Contracts
A perpetual contract, or perp, is a future with no expiry date. It was popularized by the exchange BitMEX in 2016 and is now the most traded instrument in crypto.
Without an expiry there is nothing to force the contract price back to the spot price. Exchanges solve this with funding payments.
- When the perp trades above spot, traders holding long positions pay those holding short positions.
- When the perp trades below spot, shorts pay longs.
- Payments are made at regular intervals, commonly every eight hours, though this differs by exchange.
Funding makes it costly to stay on the crowded side, which pulls the price back toward spot. It is also a real cost. A long position held for weeks during a period of high positive funding can lose a meaningful amount to funding alone.
Perps trade on centralized exchanges such as Binance, Bybit and OKX, and on decentralized platforms such as Hyperliquid, dYdX and GMX.
Margin, Leverage and Liquidation
Derivatives are traded on margin. You post collateral and control a larger position. With 10x leverage, 1,000 dollars of margin controls a 10,000 dollar position. A 1% move in the price changes your margin by 10%.
- Initial margin: the collateral needed to open a position.
- Maintenance margin: the minimum you must keep. If losses push your margin below it, the exchange closes the position. This is liquidation.
- Isolated margin: only the collateral assigned to that position is at risk.
- Cross margin: your whole account balance backs all positions, so one bad trade can drain the account.
At 10x leverage, a price move of a little under 10% against you is enough to be liquidated. At 50x, it takes less than 2%. Crypto regularly moves that much in minutes. When many leveraged positions are liquidated at once, the forced orders push the price further and trigger more liquidations. These cascades explain many of the sharpest moves in the market.
How the Three Differ
- Futures: fixed expiry, binding on both sides, no funding payments. Suited to hedging over a known period.
- Options: buyers have limited loss and pay a premium. Suited to defined-risk views or protection.
- Perpetuals: no expiry, funding payments, deep liquidity. Used mostly for short-term trading.
Regulation
Rules vary widely by country. In the United States, the Commodity Futures Trading Commission oversees derivatives markets, and many offshore platforms are not permitted to serve US retail customers. The CFTC's Learn and Protect section and its advisory on the risks of virtual currency trading are written for retail traders. The United Kingdom has banned the sale of crypto derivatives to retail consumers since January 2021. Check what is permitted where you live before opening an account.
Risks to Understand
- Liquidation: leverage can wipe out your margin on a normal daily move.
- Funding costs: holding perps is not free.
- Exchange risk: collateral sits with the exchange. FTX customers lost access to funds when it failed in 2022.
Common Mistakes
- Using high leverage because the exchange offers it.
- Trading without a stop or a plan for where the position is wrong.
- Ignoring funding and fees when holding for days.
- Using cross margin without understanding that the whole balance is exposed.
Regulators have repeatedly warned that most retail traders lose money on leveraged products.
Nothing in this article is financial advice.
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The Bitcoin price page and the Ethereum price page show the live spot prices that most derivatives are based on. The homepage shows the Fear and Greed reading and total market volume, and the exchanges page lists trading venues.