However, blockchain technology has the potential to bypass the need for centralized third parties to authorize and facilitate the creation and exchange of new financial products – for example via decentralized exchanges (DEXs). While these innovations could reshape our understanding of what is possible within the financial services sector, some such decentralized derivatives (as well as some of the DEX platforms hosting them) might fall into gray areas in terms of regulatory compliance, which might in turn increase risk for investors trading or holding DEX-generated blockchain derivatives. That said, do remember that this article is not investment or legal advice, and is only intended for informational purposes – please consult with a qualified financial professional and do your own research before making any financial decisions.

With an increasing number of institutional investors making efforts to hedge their positions in large-cap cryptos like BTC, many experts believe the trading volume lead that crypto derivatives hold over crypto spot trading might grow even larger yet. While the growing number of crypto-based derivatives is an exciting development which underscores the industry’s gradual maturation, these financial products generally still operate within the conventional framework set by legacy financial institutions. As a result, one of the most exciting syntheses of blockchain technology and the global derivatives market resides in blockchain’s potential to change the way the traditional derivatives market itself works.

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Given blockchain’s distributed, immutable design, synthetic assets launched on a blockchain network can be easier to trade and transfer relative to their conventional counterparts. In other words, blockchain-enabled synthetic assets have the ability to bring most or even all of what is currently offered in traditional financial markets into the crypto ecosystem in a way that enhances market efficiency and transparency. Furthermore, unlike conventional derivatives markets, synthetic assets on blockchain platforms pull their data from markets that operate around the clock using smart contract-based price discovery protocols such as decentralized oracles, which allows investors to benefit from longer trading periods, unencumbered by time zone restrictions.

Within the financial services sector, a derivative is a financial product whose value is linked to a characteristic of an underlying asset. In other words, the buying and selling of a derivatives contract does not involve the actual exchange of the underlying asset itself. Rather, the value of the derivative being traded is a function of a specific, pre-established metric associated with its underlying asset. A derivative can be based on practically anything, tangible or intangible, as long as it has a characteristic that can be assigned a price based on a mutually agreeable framework. Since a derivative’s value is based on a dynamic characteristic of its underlying asset, over the course of a derivative contract’s existence the market price of that contract typically fluctuates in accordance with the expected outcome of the trade.