When dealing in the stock markets, there are a number of ways to invest, hedge against uncertainty, and diversify. Options, derivatives, and direct investments are among the largest portions of investment material available.
Until recently, crypto markets have been limited to direct investment in projects and startups. Funds are normally collected via ICOs and tokens are given in return. It is important to note the difference between buying tokens for speculation in hopes of reselling them for more money at a later date and buying tokens to use them in an ecosystem or on the products a project releases, such as Ethereum, which has a large number of DApps and a large developer ecosystem.
Bitcoin Exchange Traded Funds (ETFs) have been proposed in the past but were not approved. Bitcoin futures were recently adopted by CBOE and CME, allowing institutional investors to place their native currency against the value of bitcoin. When buying futures, investors can bet for the value to increase or decrease from when they purchased the future contract(s).
What is the difference between prediction markets and derivatives?
Derivatives are normally attached to a security but are not securities themselves, so there are several types of derivatives. Derivatives can have multiple uses. A few common types are listed below:
- Futures contracts – A contract which states that you will see a given security at a specific price and that you expect the value will either increase or decrease over time.
- Options – Options are very similar to futures contracts, but the exchange of the security is not obligatory.
- Swaps – Swaps are normally used in reference to loans. This sort of derivative allows loan holders to trade loan contracts, currencies, or securities.
- Forward contracts – Forward contracts are very similar to futures contracts but are traded directly, not through an exchange.
Prediction markets allow investors to bet on the outcome of real-world occurrences, simply put, prediction markets allow investors to place money on the score of their football team in the next game. This same philosophy applies to everything from tomorrow’s weather to the outcome of the next election.
How are these being applied to cryptocurrencies?
New cryptocurrency startups are using blockchain networks to offer derivatives and futures markets. Augur is a project which provides their users a decentralized prediction market.
Users buy (REP) in order to place their bets. Once the conditions of a prediction have been met (Did it rain today in New York City? Yes.), anyone who placed the bet will either gain the tokens they won, or lose the tokens they bet.
Another cryptocurrency startup, dYdX Blockchain, which recently closed their token sale, is going to offer decentralized Ethereum derivatives and loans on the blockchain. (You can view their whitepaper here) They make use of off-chain order books and publish the results of each contract to the blockchain. dYdX is based on the 0x protocol, similarly to Augur. The 0x protocol was designed to allow token holders to trade their tokens, allowing prediction markets, derivatives, and more to be placed on the blockchain.
According to dYdX, “It’s still early days for dYdX, but we’re excited to take on the $1.2 quadrillion derivatives market.”