How To Trade Derivatives Contracts Using The Lightning Network

Trade derivative contracts using LN network

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One of the biggest criticisms of bitcoin by the altcoin community is the lack of applications built on bitcoin. Since bitcoin doesn’t have token minting abilities to create fake demand for an asset by creating new trading pairs, it isn’t as attractive to speculators as these riskier markets. Bitcoin’s global adoption is still a long way off, and a large part of current investors are speculators, riding momentum.

They don’t care about the long term growth of the asset class; they are trying to pocket spreads to acquire more dollars. While bitcoin can move significant percentage points in a single day, altcoins which are leveraged bets on top of bitcoin can move even faster due to the lack of liquidity.

Despite bitcoin’s focus on growing as a monetary network, second layer solutions like the lightning network are looking to add feature sets and financial products to the bitcoin network. Futures contracts and leverage trading has come to bitcoin via centralised exchanges and financial service providers. To access these products, investors may have to submit KYC documentation and post a certain level of collateral. These issues may put off several investors, and with the opportunity cost of hodling, some may prefer not to risk capital on these derivatives.

If you are going to be a degen, do it with sound money.

New DEFI projects built on bitcoin have emerged, offering up some exciting opportunities for those less risk-averse and who enjoy trading the markets. These services, Kollider and LN Markets, allow you to take out derivative contracts on the bitcoin price and settle instantly using the lightning network. 

Using these platforms, you can access financial contracts like:

  • Perpetual swaps
  • Long & short trades
  • Leverage trading

Why would you use derivatives?

Investors use derivatives for three reasons, either. 

  1. To hedge a position they have in the market of the underlying asset, 
  2. To increase the leverage of a trade to make a more significant spread, 
  3. or to speculate on an asset’s movement. 

Hedging a position is usually done to protect against or to insure against the risk of an asset. 

Derivatives can significantly increase leverage. Leveraging through options works well for markets with a lot of volatility. When the price of the underlying asset moves significantly and in a favourable direction, options magnify this movement. However, the opposite is also true if the market moves against you; the losses are also magnified.

Investors can also use derivatives to bet on the future price of the asset through speculation. 

Creating a trading account

Trading accounts can be set up with these lightning-based apps using an email address or maintain more privacy by creating an account using your lightning wallet. If you select the lightning wallet open, all you need to do is scan the QR code, which will create your account and provide the unique login for your account. 

How can I trade from a wallet that supports the Lightning Network?

The simple way to start trading using these platforms is to have a bitcoin wallet that supports the Lightning Network. Once you have a wallet set up and funded with (LN) Bitcoin, you can trade on these platforms. 

While advanced users who run their self-hosted Bitcoin and Lightning Nodes can connect directly to one of the platform’s nodes, having your node allows you to connect directly with the platform or establish payment channels. Lightning apps also support incoming users that wish to connect their nodes to Joule, which will enable you to transact within the browser.

Why use the lightning network for derivatives?

The lightning network offers investors the chance to use near free and instant transactions to create financial contracts. You can now access complex financial products and tradable markets 24 hours a day and do smaller transactions.

The lightning network also allows you to take instant custody of funds once you complete trades. These could be full or partial closes of trades, and you can claim that liquidity to a wallet of your choice. The lightning network also reduces the time and exposure to the third party/custodial risk.

Taking a risk on your stack

Hodling has proven to be a pretty tough bar to beat when you consider the risk-adjusted returns and is your risk-free rate. However, if you’re feeling a little risky and want to place some bets on market moves, or hedge your bitcoin exposure, then these platforms can help you do just that.

Disclaimer: This article should not be taken as, and is not intended to provide any investment advice. It is for educational and entertainment purposes only. As of the time posting, the writers may or may not have holdings in some of the coins or tokens they cover. Please conduct your own thorough research before investing in any cryptocurrency, as all investments contain risk. All opinions expressed in these articles are my own and are in no way a reflection of the opinions of The Bitcoin Manual

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