cryptocurrency delta hedging

by Malcolm Gloyer

introduction

Derivatives offer an alternative to taking direct custody of cryptocurrencies by investing in their derivatives as a means of accessing exposure to decentralised finance (DeFi). Perpetual swaps are the largest traded contract in cryptocurrency that enable investors to buy and sell cryptocurrencies like Bitcoin without owning any. These contracts do not expire and are designed to track spot prices through regular payments to parties that are in-the-money.

A BTC-PERP perpetual future contract is worth one Bitcoin with funding occurring every 8 hours. Exchanges use the current interest rate and a premium index per minute to calculate the funding rate. Since they are only trading the price value of an underlying crypto asset, the price of a perpetual futures contract has to be close to the actual price of the underlying asset.

The trading system uses a funding rate to ensure that the price of the perpetual futures contract does not move away from the spot market price of the underlying crypto asset. When the market is bullish and the price rises, the funding rate is usually positive, but when the price is falling, the funding rate is usually negative. When the funding rate is positive, there will be a premium payment from those in long positions to traders holding short positions. On the other hand, when the perpetual futures contract trades at a discount below the spot index price, the funding rate will be negative. The sellers will, at this point, pay the buyers a small fee.