Commodity Derivatives: Everything you need to know
In antiquity, societies mainly barter traded physical goods. This began with livestock and grains, and then moved on to precious metals such as silver and gold.
Even today, commodity trading is still taking place. This begs the question: Why is that the case? That’s what we set out to answer in this guide.
Apart from commodities, we’ll also examine commodity derivatives and how you can benefit from trading with them. Let’s dive right in.
What are commodities?
Commodities are tangible goods that can be traded. In most cases, commodities are split into two major categories: hard and soft.
Within the hard and soft categories, there are four different groups:
- Metals: This includes both industrial metals (aluminium, tin and copper) and precious metals (gold, silver and platinum). When stock prices are falling, investors often invest in precious metals as they tend to be stable in value.
- Energy: This includes crude oil, heating oil, petrol and natural gas. Energy is always in demand, but also highly volatile due to political events, regulations and economic shocks / natural disasters.
- Agriculture: Mainly, this group includes crops such as wheat, soybean, corn, coffee and sugar. Agricultural prices might rise due to limited food supply and population growth, but political events, weather, natural disasters and disease remain a threat.
- Environmental (livestock & meat): This group includes products such as live cattle, feeder cattle, live hogs, and meat and dairy products. This group faces many of the pros and cons the agriculture sector faces.
Why should you consider commodity trading?
Today, commodities are considered as an alternative investment. The reason being that they tend to have a low to negative correlation to stocks and bonds. What does this mean? It means that commodity prices generally move in the opposite direction of stock and bond prices.
That’s why many investors turn towards commodities to diversify their portfolio, or when the stock market has a poor outlook. But commodities have more advantages … and drawbacks. Let’s take a look at some.
Commodities: What to consider?
- Diversity: As outlined above, commodities act as a counterbalance to stocks and bonds, allowing you to mitigate the overall risk of your portfolio.
- Inflation hedge: Mostly, the price of commodities rises with inflation, while the value of a dollar shrinks. That’s why some commodities are considered to be great inflation hedges. Drawbacks
- Illiquid: Directly owning commodities can be time-consuming, expensive and risky (e.g. political events, weather, natural disasters and disease).
- Income: Unlike stocks and bonds, commodities don’t pay dividends or interest. Their return is purely based on a rise in their price — not advantageous if you are in need of constant income.
Commodities Trading: Current Options
If you’re interested in commodities, there are multiple ways you can gain exposure to them.
- Direct ownership: The simplest way is buying them directly. But direct ownership is a lot more complicated with large quantities of heavy, living or hazardous commodities such as cattle, crops or uranium.
- Future contracts & options: Because direct ownership can be a hassle, institutions tend to buy and sell futures contracts of commodities. Individual investors on the other hand often buy and sell options based on said futures contracts.
- Commodity stocks: Instead of investing in commodities directly, you can also invest in companies that produce or process commodities. That’s because in most cases, the companies’ stock price will rise and fall with their associated commodities.
- Commodity ETFs & mutual funds: ETFs and mutual funds are mostly made up of physical commodities, futures contracts and commodity stocks — a mixed bag really. But, this can provide diversity and a lower-risk, both at a lower-cost.
When considering all the options outlined above, it becomes clear that it is difficult for retail investors to gain hassle-free and straightforward exposure to commodities.
Additionally, it is also not guaranteed that they will receive the best price. That’s because the supply chain of most commodities involves multiple intermediaries. This makes the commodity life cycle slow, inefficient, error-prone and expensive.
This is where Fabric comes into play.
Trading commodities with Fabric
Fabric is a trading platform that runs on the Solana blockchain that allows you to directly invest in synthetic assets or synths.
Synths are assets that are pegged to real-world assets by means of tokens on a blockchain. This means that you can trade synthetic commodities such as fURA (uranium) or fXAU (gold) with the same prices as their “real-world” counterparts i.e. uranium or gold.
By doing so, you gain direct exposure to commodities — without needing to deal with the drawbacks outlined above.
If you want to know more about the benefits of synthetic assets and Fabric in general, check out our synthetic assets guide here.
Now, let’s check out how commodities trading on Fabric works.
Disclaimer: Currently, our platform is in beta going through final audits and should be ready for launch by the end of Q1/2022. If you’re already curious though, you can try our beta version! However, before you do anything, you first need to set up a wallet such as Phantom.
When you successfully set up your Phantom wallet, head over to the fSynth dApp and connect your wallet in the top right corner of your screen by clicking on “connect”.
In the next step, you need to get some dummy tokens. You can claim these (at no cost) by clicking on the faucet symbol in the top right corner of your screen- make sure to claim both SOL and FAB.
Next, you need to deposit some FAB as collateral.
In turn, your collateral allows you to “mint” i.e. create synthetic USD — fUSD (you’ll find this option on the right side of your screen).
Now you can swap this fUSD for any synthetic asset that is available.
The beta version of our platform supports a number of synth derivatives. Once we’re live the DAO will be able to vote on assets they wish to add to the ecosystem.
We’re excited to keep creating value for our FAB users and would love to hear what you all think about 👋
Join The FAB Family
We can’t wait for you to join the community and become a part of the FAB Family.
A big thanks to @J264G for his work on this post 💚