What is a financial instrument?
In simple terms, a financial instrument is a tradable asset. Examples include cash, precious metals (like gold or silver), a document that confirms ownership of something (like a business or a resource), a right to deliver or receive cash, and many others. Financial instruments can be really complex, but the basic idea is that whatever they are or whatever they represent, they can be traded.
Financial instruments have various types based on different classification methods. One of the classifications is based on whether they are cash instruments or derivative instruments. As the name would suggest, derivative instruments derive their value from something else (like a cryptocurrency). Financial instruments may also be classified as debt-based or equity-based.
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What is the spot market?
The spot market is where financial instruments are traded for what’s called “immediate delivery”. Delivery, in this context, simply means exchanging the financial instrument for cash. This may seem like an unnecessary distinction, but some markets aren’t settled in cash instantly. For example, when we’re talking about the futures markets, the assets are delivered at a later date (when the futures contract expires).
In simple terms, you could think of a spot market as the place where trades are made “on the spot.” Since the trades are settled immediately, the current market price of an asset is often referred to as the spot price.
What is margin trading?
Margin trading is a method of trading using borrowed funds from a third party. In effect, trading on margin amplifies results – both to the upside and the downside. A margin account gives traders more access to capital and eliminates some counterparty risk. How so? Well, traders can trade the same position size but keep less capital on the cryptocurrency exchange.
When it comes to margin trading, you’ll often hear the terms margin and leverage. Margin refers to the amount of capital you commit (i.e., put up from your own pocket). Leverage means the amount that you amplify your margin with. So, if you use 2x leverage, it means that you open a position that’s double the amount of your margin. If you use 4x leverage, you open a position that’s four times the value of your margin, and so on.
What is the derivatives market?
Derivatives are financial assets that base their value on something else. This can be an underlying asset or basket of assets. The most common types are stocks, bonds, commodities, market indexes, or cryptocurrencies.
The derivative product itself is essentially a contract between multiple parties. It gets its price from the underlying asset that’s used as the benchmark. Whatever asset is used as this reference point, the core concept is that the derivative product derives its value from it. Some common examples of derivatives products are futures contracts, options contracts, and swaps.
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What are forward and futures contracts?
A futures contract is a type of derivatives product that allows traders to speculate on the future price of an asset. It involves an agreement between parties to settle the transaction at a later date called the expiry date. As we’ve discussed with derivatives, the underlying asset for a contract like this can be any asset. Common examples include cryptocurrency, commodities, stocks, and bonds.
The expiration date of a futures contract is the last day that trading activity is ongoing for that specific contract. At the end of that day, the contract expires to the last traded price. The settlement of the contract is determined beforehand, and it can be either cash-settled or physically-delivered.
What are forward and futures contracts?
A futures contract is a type of derivatives product that allows traders to speculate on the future price of an asset. It involves an agreement between parties to settle the transaction at a later date called the expiry date. As we’ve discussed with derivatives, the underlying asset for a contract like this can be any asset. Common examples include cryptocurrency, commodities, stocks, and bonds.
The expiration date of a futures contract is the last day that trading activity is ongoing for that specific contract. At the end of that day, the contract expires to the last traded price. The settlement of the contract is determined beforehand, and it can be either cash-settled or physically-delivered.
This is why perpetual futures contracts implement a funding fee that’s paid between traders. Let’s imagine that the perpetual futures market is trading higher than the spot market. In this case, the funding rate will be positive, meaning that long positions (buyers) pay the funding fees to short positions (sellers). This encourages buyers to sell, which then causes the price of the contract to drop, moving it closer to the spot price. Conversely, if the perpetual futures market is trading lower than the spot market, the funding rate will be negative. This time, shorts pay longs to incentivize pushing up the price of the contract.
To summarize, if funding is positive, longs pay shorts. If funding is negative, shorts pay longs.
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