Underlying Assets in Derivatives: Functions and Types

Crypto derivatives give users a new option, not holding the physical asset. By using derivatives, it allows individuals to avoid navigating wallets and other complications concerning the market. First, let’s discuss and explore underlying assets in derivatives.

What Is an Underlying Asset?

So, what is an underlying asset? Is it one of the key features of DeFi?

In specific scenarios, crypto tokens may give the holder interest in an underlying asset. Underlying assets typically come in commodities like gold, wheat, or oil, intangible assets like licenses, stocks, or patents, and other miscellaneous assets like artwork, real estate, etc.

Underlying assets influence the value of the derivative security. The rise and fall of the derivative security value usually go hand-in-hand with the value of the underlying asset involved. When deciding to invest in the derivatives market, you must clearly understand how market conditions will impact or influence the value of underlying assets.

How Underlying Assets Work

Underlying assets influence the value of a derivative security, such as bonds, stocks, interest rates, and currencies. There is an essential link between the derivative and its underlying security. Price movements or fluctuations are directly related to the trends and changes concerning the underlying assets.

A comprehensive understanding of the underlying assets will be essential if investors engage in trading derivatives. However, derivatives trading is somewhat complicated, and losses can be substantial if you aren’t careful.

Types of Underlying Assets in Derivatives

You can typically break down derivatives into four different types. Which type it ends up being will rely on the smart contract's conditions. These four forms include:

1. Options Options contracts give traders a choice, but not the obligation, to purchase/sell underlying assets at a designated future date and cost.
2. Futures Futures contracts are legal agreements between two parties to purchase or sell underlying assets at a designated price and date in the future.
3. Perpetual Perpetual contracts are different as they have no expiration or settlement date requirement. Some circumstances enable traders to keep their positions open-ended.
4. Swaps A swap contract is held between two parties to exchange cash flows later, according to a particular formula. These are OTC contracts and are not traded on exchanges.

Hedging & Speculation Underlying Assets in Derivatives

Derivatives are commonly utilized for either speculation or hedging. Let’s quickly go over both.

Hedging

Hedging protects your crypto portfolio from unwanted market changes. Hedging involves opening positive and negative positions correlating to any existing positions. Futures can protect investments without compromising current holdings, allowing you to hedge for an affordable fee.

Speculation

Derivatives are commonly used to speculate on future prices of crypto. Futures contracts can help you bet on low prices, AKA going short. If the price drops, your short position earns a profit. Derivatives also allow you to gain exposure to an underlying asset at an attractive price.

For example, you could bet on the price for valuing the DeFi Pulse Index via a futures contract. Studying the trends and researching the valuation forecast for this index may help you create bets and profit from them if done correctly and with finesse.

Creating & Funding Your Derivatives Wallet

You’ll first need to create a cryptocurrency exchange wallet and follow these steps:

1. Access your wallet or create your wallet on the crypto.com exchange.
2. Select “derivatives wallet” from the navigation bar, follow the instructions on-screen and accept the terms and conditions.
3. After you’ve agreed to their terms, your application will be reviewed.
4. Once approved, your derivatives wallet will be activated, and you can access your derivatives wallet page.
5. Fund your wallet by clicking on the “transfer” option, and proceed to transfer eligible assets from your spot wallet.
6. Accepted virtual assets currently include USDT and USDC.

Conclusion: Underlying Assets in Derivatives

Crypto derivatives are necessary to the crypto ecosystem, as they are a part of any well-established or mature financial system. Derivatives play a vital role in developing and growing the crypto space as a recognized and reliable asset class.

Derivatives are just one of the moving gears in the revolutionary use cases of DeFi. Peer-to-peer lending, financial sovereignty, decentralized insurance options, and accessible payment solutions are part of the DeFi movement.