Crypto Derivatives: A Step-by-Step Guide
I’m working on a stablecoin startup. One of the most significant use cases for stablecoins (along with global payments) is their use in crypto derivatives. Thus, I’ve decided to compile some of my research into a step-by-step guide.
Crypto derivatives are financial contracts that derive their value from the price of an underlying cryptocurrency. In other words, they let traders speculate on price movements without owning the asset itself. Common crypto derivatives include futures contracts, options, swaps and perpetual swaps, which allow both large and small players to hedge risk or amplify returns. Last year, open interest in crypto futures and options topped tens of billions of dollars, and now dominates crypto trading volume. They play key roles in crypto markets by helping to manage risk and boost liquidity.
Understanding these tools is essential for both newcomers and institutional traders. I’ll walk through each major type of crypto derivative, explain how collateral and margin work, and then give my take on what I believe is missing in today’s system!
If I missed anything or made a mistake, please reach out! Also, please note this article is for crypto derivatives only, so I won’t be talking much about the TradFi applications.
1. Futures Contracts
A futures contract is an agreement to buy or sell a cryptocurrency at a predetermined price on a specific future date. The buyer commits to purchase (and the seller to sell) the asset at the agreed price when the contract expires. In crypto markets, futures allow traders to bet on a coin’s future price without holding the coin itself. For example, a Bitcoin futures trader can profit if they correctly predict BTC’s price rise or fall, even if they never own any Bitcoin!
Key features of futures contracts include:
They expire on a set date (unlike perpetual swaps, which have no expiry).
They may be cash-settled or deliverable (some settle in USD stablecoins, others in the actual crypto).
Traders can go long (betting the price will rise) or short (betting it will fall).
Margin requirements: Traders must post collateral to open and maintain futures positions (more on collateral below).
Hedging use cases: Futures can protect (“hedge”) miners or investors against adverse price moves.
Futures often allow leverage, meaning a small collateral deposit can control a much larger position, amplifying both gains and losses. This can magnify profits but also increase the risk of large losses.
2. Perpetual Swaps (Perpetual Futures)
Perpetual swaps (or perpetual futures) are very similar to futures, but with one key difference: they have no expiration date. Traders can hold them indefinitely if they maintain a sufficient margin. Perpetual swaps are extremely popular in crypto because they let traders maintain positions without worrying about rolling contracts at expiration.
Perpetual swaps still track the underlying price through a special funding mechanism. Exchanges periodically charge or pay a funding rate between longs and shorts to keep the swap price aligned with the spot price. If the perpetual price is above the spot price, longs pay shorts; if below, shorts pay longs. This funding rate incentivizes traders to keep the contract price in line with the actual market.
Important aspects of perpetual swaps:
No fixed expiry: positions can be held continuously.
Funding fees: Traders periodically pay or receive funding based on market conditions.
Leverage and margin: Like futures, perpetuals allow high leverage, so margin calls apply.
Liquidity: Perpetuals are often very liquid in crypto, making them a go-to tool for day traders.
Because perpetual swaps trade close to the spot price (thanks to the funding mechanism), they act almost like an unlimited futures contract. They have helped crypto traders speculate and hedge on a 24/7 basis.
3. Options Contracts
A crypto option is a contract that gives the holder the right, but not the obligation, to buy or sell a cryptocurrency at a specified strike price on or before a set expiration date. There are two basic types: a call option (right to buy) and a put option (right to sell) at the strike. The buyer of the option pays a premium up front for this right.
Options are useful for risk management because they limit downside while allowing upside. For example, buying a Bitcoin call with strike $40,000 means you can buy bitcoin at $40k if it goes higher — or simply let the option expire if prices stay below $40k, losing only the premium you paid. In contrast to futures, your maximum loss is the premium (cost of the option).
Key points about options:
Premium and strike: The buyer pays a premium; the strike is the agreed price.
Leverage with limited loss: You get exposure to price moves but cap your loss at the premium paid.
Expiry date: Options expire by a certain date (American-style options can be exercised any time before expiry; European only at expiry).
Strategies: Traders use spreads, straddles and other multi-option strategies to profit in various scenarios.
Volatility plays: Option prices move with volatility — higher volatility generally raises option premiums.
Options are widely offered on crypto exchanges for major assets like Bitcoin and Ether, and are increasingly used by institutions for hedging and yield strategies.
4. Collateral and Margin
To trade crypto derivatives, traders must put up collateral (margin) to cover potential losses. This collateral is typically in the form of stablecoins (like USDC, USDT, BUSD) or occasionally other cryptocurrencies (BTC, ETH) on margin. The purpose is to ensure that if the market moves against a position, the exchange or counterparty can liquidate enough collateral to cover losses.
Most crypto derivatives platforms require over-collateralization. For example, if you want to open a $10,000 position, you might need to deposit $1,000 or more in stablecoins. If your position loses value beyond a threshold, it will be liquidated using your collateral. This margin system amplifies both gains and losses: a highly leveraged trade with a small price swing can exhaust collateral quickly.
Stablecoins play a central role in collateral. A stablecoin is a cryptocurrency designed to maintain a stable value, usually pegged 1:1 to a fiat currency or a commodity. Since traditional cryptocurrencies are highly volatile, traders use stablecoins to avoid adding crypto price risk to their margin. In practice, the two most popular collateral coins are USDT and USDC (both USD-pegged). For example, one might deposit 1,000 USDC as collateral, giving a $1,000 margin to open trades.
The reliance on stablecoins means collateral risk is tied to those pegs. Fiat-backed stablecoins hold reserves to maintain their value, but history shows even stablecoins can sometimes lose their peg (e.g. algorithmic UST, or temporary USDC depeg). Nonetheless, for now, the crypto derivatives market depends heavily on single-currency stablecoins (mostly USD-pegged) as collateral.
5. What I Believe is Missing: Multi-Currency Stablecoins
Today’s crypto derivatives markets implicitly run a “dollar standard” by using USD-pegged stablecoins as collateral. This creates a single-currency concentration: traders worldwide hold collateral tied to the US dollar. That has pros and cons. On one hand, the USD is globally accepted and liquid. On the other hand, it means traders remain exposed to USD volatility. As one analyst notes, even stablecoins “pegged 1:1 to a single fiat” still fluctuate in value relative to other currencies or commodities if that fiat moves. In short, a trader funded in USD tether still faces FX risk if dollar strength changes.
The lack of a multi-currency peg is a gap in crypto collateral. Imagine an ideal stablecoin collateral that reflected a basket of currencies: then traders would not be tied to the fortunes of any one economy. Some projects have toyed with the idea. For example, the Terra (LUNA) blockchain once issued TerraSDR (SDT), an algorithmic stablecoin pegged to the IMF’s Special Drawing Rights currency basket. TerraSDR was specifically designed to track the SDR (a blend of USD, EUR, CNY, JPY, GBP) rather than any single nation’s currency. Terra even partnered with platforms like Fantom to launch this SDR-pegged coin.
Why does this matter? A basket peg can reduce volatility and diversify risk. In other words, a multi-currency peg is less susceptible to shocks in any one currency. It also promotes neutrality: because no single country’s fiat dominates the peg, regulators have less reason to object on national sovereignty grounds. In effect, an SDR peg provides monetary neutrality, appealing to global traders and institutions who want to avoid dollar or euro bias.
6. SDR-Pegged Stablecoins
The IMF’s Special Drawing Right (SDR) is an international reserve asset whose value is based on a basket of five major currencies (USD, EUR, CNY, JPY, GBP). It is not itself a circulating currency, but it represents a weighted average of those currencies. An SDR-pegged stablecoin would aim to track that basket value on a blockchain. This could combine the stability of fiat-backed coins with the resilience of a diverse peg.
Terra’s SDT was one early attempt: SDT was “largely based on the IMF’s Special Drawing Rights”, intended to be “resilient against price movements”. By pegging to the SDR, SDT’s design sought to mitigate the extreme volatility seen in purely crypto or single-fiat assets. While Terra’s larger stablecoin model ultimately failed, the idea remains intriguing.
An SDR-based stablecoin collateral could help crypto derivatives in several ways:
Improved Risk Management: Because the peg spans multiple economies, global shocks are averaged out. A sudden drop in the USD (for example) would only partly affect the SDR basket, meaning the stablecoin’s value would be less volatile than a USD-only coin.
Lower Volatility: Historical data on basket-pegged models suggests they tend to have lower volatility than single-currency pegs. The SDR basket mix would smooth out swings in any one currency.
Neutrality & Global Acceptance: An SDR coin is not beholden to one country. It “doesn’t amplify demand for any one fiat currency,” reducing geopolitical risk. This neutrality could make the stablecoin more acceptable to international traders and institutions.
Regulatory Benefits: By being truly global, an SDR-backed coin might sidestep some regulatory issues tied to dollarization, since it is inherently multilateral.
In sum, an SDR-pegged stablecoin offers a built-in diversification: users hold a mix of the world’s largest currencies in one token. This could be a game-changer for crypto derivatives markets, which need deep, liquid, and stable collateral. It would allow exchanges and institutional traders to post collateral that is less tied to the ups and downs of any single national economy.
In conclusion, while USD-pegged coins will remain dominant in the near term, innovation in this space is worth watching. However, I believe my idea of an SDR pegged coin illustrates a straightforward concept of a global stablecoin stable in most economies. If realized, such multi-currency stablecoins could usher in a more resilient and neutral foundation for the next generation of crypto derivatives.