Perpetual futures are a type of derivative contract that has no expiration date. Unlike traditional futures, they allow continuous speculation on an asset’s price.
What are perpetual futures and how can you start trading them?
This guide dives into perpetual futures to show you how they work and the opportunities they offer.
Perpetual futures (also called perpetual swaps) are derivative contracts that let you speculate on an asset’s future price without expiration. Unlike traditional futures contracts with a specified expiration date, perpetual futures contracts can be held indefinitely, allowing for continuous speculation on price movements.
This flexibility makes them particularly popular in the crypto market, constituting c. 90% of the total trading volume.
The perpetual futures market operates by closely aligning with the spot price of the underlying asset. This is done via a mechanism known as the funding rate.
When you combine the funding rate with the absence of contract rollovers, you get a simplified trading process and a good cost reduction.
That’s why perpetual futures trading has become a mainstay for many traders seeking to capitalize on market volatility and price fluctuations.
Perpetual futures contracts stand out from traditional ones mainly because they don’t expire. This provides greater flexibility in managing investments and eliminates the need for periodic contract rollovers, a must-have for traditional futures contracts.
As you can tell, avoiding these rollovers saves costs and simplifies trading, making perpetual contracts a very attractive option for crypto traders.
Another key difference between these two contract types is that perpetual futures contracts work continuously without managing contract expirations. This again cuts the costs and simplifies position management without the complexities of traditional futures contracts.
These differences explain why perpetual futures are a go-to choice for many traders.
Perpetual futures contracts are designed to be accessible and efficient, expanding trading opportunities for retail investors beyond institutional players.
The high trading volumes in the perpetual futures market, estimated between $75–$100 billion daily underscore their significance in the financial markets.
However, due to market volatility and leveraged positions, perpetual swaps can carry more risk than traditional futures. To manage such risks, you must clearly understand mechanisms like the funding rate and leverage requirements.
First, there’s the funding rate mechanism, which helps maintain the perpetual futures price near the market price and ensures a close relationship with the underlying asset’s value.
The funding rate involves periodic payments between buyers and sellers to align the futures price with the spot price, helping to maintain market equilibrium. Depending on the exchange or product, these payments may occur every eight hours or less. Some platforms use intervals, such as one hour, four hours, or less.
Traders can receive or pay a funding rate depending on their position and market conditions. This mechanism impacts profitability, especially for long-term positions, since funding rates can incur additional costs.
This is why a clear understanding of funding rates and timing is crucial for effective position management.
One of the advantages of perpetual futures is the ability to use leverage. This lets you control larger positions with a smaller amount of capital.
High leverage means that you can amplify potential gains. However, it also increases the risk of substantial losses if the market moves against your position. That’s why leveraged positions call for careful management – this is how you avoid margin calls and potential liquidation.
Margin requirements are vital for effective risk management in perpetual futures trading. There are two types of margin requirements:
If your margin balance drops below the maintenance margin requirement, you risk that your position gets liquidated. Using margin is a safety net for the trader and the exchange, ensuring that potential losses can be covered.
By understanding and adhering to margin requirements, you can better manage their leveraged positions and mitigate the risks of perpetual futures trading.
Perpetual futures trading comes with its benefits and risks.
On the one hand, perpetual futures contracts let you maintain positions indefinitely and capitalize on price volatility. This flexibility and the potential for high leverage make perpetual futures attractive.
On the other hand, the associated risks of perpetual futures trading cannot be overlooked. Using leverage can amplify gains and losses, and traders must be vigilant in managing their positions to avoid margin calls and liquidation. Regularly reviewing market trends and employing effective risk management strategies are essential for anyone involved in perpetual futures trading.
Let’s take a closer look at the advantages and risks of perpetual futures contracts.
Perpetual futures offer several advantages over traditional futures contracts:
Despite the numerous advantages, trading perpetual futures also comes with significant risks:
Recognizing the risks and implementing robust risk management practices are essential to successful perpetual futures trading.
Perpetual futures have practical applications that extend beyond mere speculation. They’re used in various trading strategies, including hedging and arbitrage, to manage risk and capitalize on market inefficiencies. This versatility makes perpetual futures valuable for individual traders and institutional investors.
Let’s dive into the specific applications of perpetual futures in speculation, hedging, and arbitrage. Each strategy leverages the unique characteristics of perpetual futures to achieve different financial objectives.
Speculation is one of the primary uses of perpetual futures. You can speculate by predicting future price movements and opening positions accordingly.
The indefinite holding period lets you speculate on future asset prices without concern for expiration dates. This indefinite holding period is particularly beneficial in volatile markets, where you can adjust their positions based on ongoing price fluctuations.
High leverage further enhances the speculative potential of perpetual futures, enabling you to control larger positions with less capital. However, it’s important to note that speculation carries inherent risks, and you must be prepared for substantial losses if your predictions do not materialize.
Perpetual futures are also widely used for hedging purposes. By taking positions in perpetual futures, you can protect yourself against potential price drops in the underlying assets.
For example, if you hold a long position in a particular asset, you can hedge against potential losses by taking a short position in perpetual futures.
This strategy helps to offset potential losses in the underlying asset positions, providing a safety net in volatile markets. Hedging with perpetual futures allows traders to manage risk more effectively, ensuring their portfolios are better protected against adverse price movements.
Arbitrage is another practical application of perpetual futures. Traders can exploit price discrepancies between the perpetual futures market and the spot market to generate profits. This strategy involves simultaneously buying in one market and selling in another to capitalize on the price differences.
Arbitrage opportunities are particularly prevalent in the cryptocurrency market, where price volatility and market inefficiencies create frequent arbitrage conditions.
You can achieve consistent profits by effectively leveraging these opportunities while contributing to market efficiency and price discovery.
Initially proposed by Robert Shiller in 1992, perpetual futures have become a staple in modern financial markets, especially within the cryptocurrency sector. Their ability to offer continuous trading without an expiration date has made them particularly attractive to traders and investors seeking flexibility and liquidity.
The regulatory landscape for perpetual futures varies by jurisdiction, reflecting different approaches to oversight and compliance. Understanding these regulatory frameworks is crucial to ensure that you operate within legal boundaries and adhere to trading standards set forth by regulatory bodies.
Robert Shiller established the concept of perpetual futures in 1993, building on ideas from the late 1980s. However, it wasn’t until 2016 that perpetual futures were introduced to the trading market, with BitMEX launching the first perpetual swap contract for Bitcoin. This innovation marked a significant milestone in the evolution of perpetual futures, paving the way for their widespread adoption in cryptocurrency.
Since then, perpetual futures markets have gained steam, particularly in crypto markets, which have overtaken traditional futures in popularity. Their continuous trading nature and alignment with spot prices through funding rates have made them a preferred choice for many traders.
The regulatory environment for perpetual futures is diverse and varies significantly across different countries.
In the United States, the Commodity Futures Trading Commission (CFTC) is the primary regulatory authority overseeing perpetual futures contracts. This regulatory oversight aims to ensure compliance with local laws, understand margin requirements, and adhere to trading standards.
However, many cryptocurrency exchanges offering perpetual futures operate in jurisdictions with more lenient regulations. This lack of strict oversight can pose risks, as traders may not have the same level of protection as they would under more stringent regulatory frameworks.
Always ensure you’re aware of the regulatory landscape of the platforms you use to ensure compliance and safeguard their investments.
Bitcoin perpetual futures have become one of the most traded instruments in the cryptocurrency market.
In 2022, the daily trading volume of Bitcoin perpetual futures across exchanges reached a median of 101.9 billion, highlighting their popularity and liquidity. A trader who goes long on a Bitcoin perpetual futures contract and sees the price rise to $35,000 can earn a profit of $25,000, demonstrating the significant profit potential.
However, trading Bitcoin perpetual futures is not without risks.
Market volatility and sudden price declines can lead to substantial losses, especially when leveraging is involved. Grasping these dynamics is essential to making informed decisions and managing your positions effectively.
When trading perpetual futures, it is essential to understand both the benefits and risks involved. The flexibility and high leverage these contracts offer can lead to significant profits, but they also have the potential for substantial losses and high funding fees. Thorough due diligence and continuous education are critical steps for any trader.
Effective risk management protocols, like stop-loss orders and diversified investments, can mitigate potential losses. Evaluating trading strategies and staying informed about market trends helps traders navigate the perpetual futures market more confidently.
Third-party centralized exchanges (CEX) like Binance, Bydfi, or Kraken store crypto assets on their platform and protect consumers' assets like banks. They’re also liable for user assets in their possession. So, trading perpetual swaps on CEX is like trading stock derivatives. CEXs are secure, have a robust KYC procedure to prevent theft and offer customer support.
Centralized exchanges are very liquid due to their increased trading volume, giving customers the confidence to trade their crypto assets anytime. Centralized systems trade faster than decentralized ones because nodes are updated less often. They often come with user-friendly interfaces that simplify transactions.
Although centralized platforms assist investors, they’re vulnerable to hacking and cracking. CEXs are vulnerable to hackers since databases centralize user data.
DEXs, like Uniswap and SushiSwap, are crypto trading platforms without a central authority. They provide direct peer-to-peer trading without intermediaries. Other examples include Synthetix, Dydx, and Jupiter running on Solana.
Unlike centralized exchanges, decentralized platforms use distributed ledgers and smart contracts to reduce transaction fees and server downtime. Decentralized interactions are transparent. They update blockchain trading transactions directly. No database entries are needed; thus, all DeFi users can see live transactions.
When trading perpetual futures, it is essential to understand both the benefits and risks involved. The flexibility and high leverage these contracts offer can lead to significant profits, but they also have the potential for substantial losses and high funding fees. Thorough due diligence and continuous education are critical steps for any trader.
Effective risk management protocols, like stop-loss orders and diversified investments, can mitigate potential losses. Evaluating trading strategies and staying informed about market trends helps traders navigate the perpetual futures market more confidently.
Third-party centralized exchanges (CEX) like Binance, Bydfi, or Kraken store crypto assets on their platform and protect consumers' assets like banks. They’re also liable for user assets in their possession. So, trading perpetual swaps on CEX is like trading stock derivatives. CEXs are secure, have a robust KYC procedure to prevent theft and offer customer support.
Centralized exchanges are very liquid due to their increased trading volume, giving customers the confidence to trade their crypto assets anytime. Centralized systems trade faster than decentralized ones because nodes are updated less often. They often come with user-friendly interfaces that simplify transactions.
Although centralized platforms assist investors, they’re vulnerable to hacking and cracking. CEXs are vulnerable to hackers since databases centralize user data.
DEXs, like Uniswap and SushiSwap, are crypto trading platforms without a central authority. They provide direct peer-to-peer trading without intermediaries. Other examples include Synthetix, Dydx, and Jupiter running on Solana.
Unlike centralized exchanges, decentralized platforms use distributed ledgers and smart contracts to reduce transaction fees and server downtime. Decentralized interactions are transparent. They update blockchain trading transactions directly. No database entries are needed; thus, all DeFi users can see live transactions.
Perpetual futures are a powerful financial instrument offering flexibility and high leverage, making them a popular choice in cryptocurrency. Understanding how perpetual futures contracts operate, including the funding rate mechanism and leverage requirements, is crucial for effective trading.
While the benefits are significant, the associated risks, such as potential losses and high funding fees, necessitate careful risk management and informed decision-making.
As the perpetual futures market evolves, traders must stay educated and adapt to new developments. By leveraging the insights and best practices outlined in this guide, traders can navigate the complexities of perpetual futures trading and capitalize on its opportunities.
The funding rate in perpetual futures contracts is the periodic payment made between traders, where longs pay shorts to align the futures price with the underlying asset's market value. This mechanism ensures price stability in the contract.
Funding in perpetual futures contracts occurs every eight hours (or less, depending on the platform). This regular interval ensures continuous adjustment of the contract prices.
Perpetual futures contracts don’t expire, enabling traders to maintain their positions indefinitely as long as they adhere to the maintenance margin requirements. This feature offers flexibility in trading strategies.
Perpetual futures contracts offer high leverage and trading flexibility without a set delivery date, which can enhance profit potential. This makes them an attractive option for traders seeking dynamic market engagement.
Trading perpetual futures entails significant risks, including substantial losses from high leverage, margin calls, and liquidations, particularly in volatile markets. It's crucial to manage these risks carefully to protect your investments.
At 4soft, we help develop smart contracts that support decentralized derivatives, including perpetual futures. This enables secure, transparent, and efficient solutions, allowing traders to fully leverage the potential of decentralized markets. If you're interested, feel free to contact us to learn more!
