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This is a chapter from the book Token Economy (Third Edition) by Shermin Voshmgir. Paper & audio formats are available on Amazon and other bookstores. Find copyright information at the end of the page.
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Derivatives are financial instruments that allow investors to gain exposure to the price movement of an underlying asset without owning the asset itself. Synthetics are a special type of derivative that has gained importance in traditional finance. Together with derivatives, synthetics have become one of the most important use cases for tokenization. This chapter will explain why many token use cases presented in this book are derivatives by nature and why it is important to understand the core concepts of financial derivatives before one can grasp the potential implications of tokenization on money, finance, and the real economy.
Traditional finance distinguishes between two primary types of financial instruments: securities and financial derivatives. Securities include equity instruments (assets you can own, such as company shares), debt instruments (such as mortgages or bonds), and hybrid instruments (such as convertible bonds). Derivatives, on the other hand, are financial contracts that derive their value from an underlying asset or economic indicators (such as interest rates or indices).
Unlike securities, derivatives separate ownership from market risk, allowing traders to gain exposure to price movements without actually owning the underlying asset. Instead, they rely on contractual agreements that can be bought, sold, and traded independently. The underlying asset of a derivative can be equity- or debt-based, another derivative, or even a derivative of a derivative, which adds layers of complexity to their valuation. Common examples of derivatives include forward commitments such as futures, forwards, and swaps, as well as claims like options, credit derivatives (like credit default swaps), and asset-backed securities. Traditionally, derivatives were traded over the counter (as non-standardized financial contracts) rather than on stock exchanges (where only standardized financial contracts are exchanged). However, since the early 2000s, exchange-traded derivatives have become more common, with specialized derivative exchanges and even traditional stock exchanges offering these products.
Derivatives have also become integral to the tokenized economy, with smart contracts automating their creation, execution, and settlement. Smart contracts allow for the programming of all terms and margin requirements of a derivative agreement between counterparties. These contracts can be automatically executed based on external data provided by price feed oracles, which supply information about the underlying asset’s market value. Additionally, automated market makers (AMMs) can facilitate trading by allowing participants to speculate not only on asset prices but also on economic indicators such as interest rates.
Derivatives serve various purposes, including generating market liquidity, accessing hard-to-trade assets or markets, hedging against price movements, and increasing exposure for speculative reasons. A key function of derivatives markets is price discovery—the process of determining the current value of an asset. Reliable price discovery depends on factors like market structure, liquidity, and access to accurate information, contributing to a more efficient market. In traditional finance, robust derivatives markets help predict market risk and enable investors to take informed positions, such as purchasing options to protect their portfolios. This can lead to smoother market adjustments—a benefit that also applies to crypto derivatives.
The first crypto futures emerged in 2011 on an online platform called “ICBIT.” These futures were often negotiated directly online, but demand remained low due to Bitcoin's limited adoption at the time. However, as both retail and institutional investors began entering the crypto market, demand for more sophisticated financial products grew. In 2014, “BitMEX” introduced a suite of derivative products, including perpetual swaps—a derivative concept that had existed since the 1990s but was largely unused in traditional finance. BitMEX successfully adapted perpetual swaps for crypto markets, and they remain one of the most widely traded derivative instruments on crypto exchanges today. In 2017, “Deribit” launched the first Bitcoin options, while “LedgerX” became the first regulated clearinghouse and swap execution facility to offer fully collateralized, physically settled digital currency swaps and options. In 2019, specialized crypto derivatives exchanges such as “Quedex” or “Bakkt” were launched, and traditional financial institutions like the “Chicago Board Options Exchange” and the “Chicago Mercantile Exchange” began offering Bitcoin futures. This development marked a significant milestone, providing institutional investors with a regulated marketplace to trade crypto derivatives. The resulting legitimacy drove increased adoption, leading to a surge in both the spot market and derivatives trading volumes.
The COVID-19 pandemic in 2020 accelerated these trends, alongside the rapid growth of the DeFi ecosystem built on the Ethereum network. Both factors attracted a new wave of retail and institutional investors, propelling BTC, ETH, and other crypto assets to unprecedented all-time highs and fueling further demand for derivatives. As the market matured, even centralized exchanges traditionally focused on spot trading began offering derivative products. Platforms like Binance, OKX, Huobi, Bit.com, and FTX expanded their services to include crypto futures, options, and perpetual swaps. In 2021, Crypto.com—one of the longest-standing spot exchanges—launched its own derivatives platform. These developments attracted traditional financial players into the tokenized derivatives market. By early 2022, derivatives trading volumes surpassed spot trading volumes for the first time.
However, increasing regulatory scrutiny in the U.S. and Europe led many derivative-focused exchanges to relocate to offshore jurisdictions. Countries in Asia, particularly Singapore, became hubs for these platforms. Offshore exchanges often operated with looser regulatory oversight, enabling faster onboarding, higher trading leverage, and increased product innovation. Yet, this environment also introduced higher counterparty risks for both institutional and retail investors. While many offshore platforms operated responsibly, others exploited the lack of oversight. This regulatory gap enabled scandals such as the collapse of FTX, a prominent derivatives exchange that was headquartered in the Bahamas and filed for bankruptcy after misappropriating customer funds.
The flexibility of derivatives allows them to be designed with varying levels of risk and leverage, enabling their use for speculative purposes or as hedging tools. Traditional derivatives include futures, forwards, and swaps, which obligate the parties to fulfill the terms of the contract at a future date. In contrast, options offer the right, but not the obligation, to enter into a contract under pre-specified terms. When used for hedging, derivatives act as personalized insurance mechanisms to mitigate financial risk associated with potential future events. The following derivatives exist in the crypto space: