Trading virtual currencies can be a challenge for any investor. The key to figuring out how to do it right is knowing the definitions. What, exactly, does it mean to trade derivatives, and how is that different than exchanging regular cryptocurrency contracts?

If you don’t like the idea of having to put a ton of money on the line every time to venture into the market, consider using futures, forwards, and even a cryptocurrency CFD (contract for difference). It’s easy to get spooked by all the unusual terminology, particularly if your only experience is buying and selling old-school stocks and bonds. Know the following definitions and key points and you’ll be well on your way to making money with CFDs on virtual currency.

The Two Kinds of Derivatives

If you count options, there are three main types of derivative trading. For currency enthusiasts, however, there are only two kinds that count: futures and forwards. It can be confusing because the two are very similar. Both are formal contracts in which people agree to buy or sell an asset at some named date in the future for a set price. If I agree to sell, and you agree to buy, 100 shares of IBM stock one year from today for $150 per share, we have a forward agreement. It’s not a futures contract for the sole reason that we make the deal privately, just between ourselves. Futures trades take place in public, on open exchanges. Other than that, the two kinds of deals are virtually identical.

Know These Facts Before Risking Your Money

If you have a hankering to buy and sell crypto derivatives such as a cryptocurrency CFD, you need to know that their value is based on a real asset, like Bitcoin. Changes in the daily price of Bitcoin will affect the prices of future, forward, and any other type of non-traditional deal where Bitcoin (or some other form of virtual money) is the underlying asset.

Traditional Methods

If I decide to buy one BTC (Bitcoin) for the current price of $9,286, I’m hoping that the price will go up between now and when I sell it. If the price spikes to $12,000, for example, by next week, I might decide to sell, thus banking a profit of more than $2,700. That’s what brokers call a traditional, or vanilla trade. I bought something, held it, and then unloaded it when the price went up.

Derivative Methods

If you purchase a futures contract on Bitcoin, you agree in writing that you will buy some specific number of coins at some fixed date in the future for a set amount of money. You might agree to buy three BTC coins nine months from today for $10,000 each. Of course, I’ll hope that the current value, $9,286, goes up substantially between now and then. If it rises to $12,000, you’ll have the luxury of buying 3 BTC coins at a huge discount. But if the coin’s value falls to $8.000, you’re going to face a rather significant loss of 3 x (10,000-8.000), or $6,000 because you’ll have to buy (according to the legal agreement) 3 BTC for $10,000 each, even though the value, nine months from now, falls to $8,000 per BTC coin.