In trading, a futures contract is a commitment to buy or sell an asset, like a commodity, currency, or digital asset, at a set price, but the actual trade happens in the future. Unlike spot markets with instant transactions, futures involve trading a contract representing the asset, with the real exchange or cash settlement occurring later. This approach combines forecasting, commitment, and strategy, essential for experienced traders.

Perpetual contracts are a special kind of futures contract without an expiry date, allowing traders to hold positions indefinitely, unlike traditional futures where transactions are fixed for a specific future date. This flexibility in perpetual contracts offers new strategic opportunities for long-term market engagement, making them attractive for extended market strategies or hedging.

Perpetual Swaps, Perps, Perpetual Markets, and Perpetual Futures are interchangeable. They refer to the same product.

Here’s a breakdown of the key features and advantages of perpetual futures:

Features of Perpetual Futures:

1. No Expiry Date: Unlike traditional futures contracts that have a fixed expiration date, perpetual futures contracts do not expire. Traders can hold their positions indefinitely.

2. Funding Rates: Perpetual futures contracts include a funding mechanism that helps keep the market price of the contract close to the underlying asset’s spot price. Funding payments are exchanged between long and short-position holders.

These rates play a crucial role in aligning the perpetual futures contract price with the index price, helping to bridge any gaps and keep the contract close to spot prices. Funding rates not only reflect market behavior but also provide insights into derivative market dynamics. They are a key indicator of market sentiment, with positive rates indicating bullish trends and negative rates suggesting bearish trends. Traders use these rates to understand price expectations and to gauge the impact of leveraged positions in the market.

The funding rate mechanism in perpetual futures serves to ensure the contract price remains close to the actual spot price of the underlying asset. This is achieved through regular payments between long and short position holders, based on the difference between the perpetual contract and spot prices. When the perpetual futures price exceeds the spot price, long position holders pay short position holders, encouraging more short positions to lower the futures price. Conversely, if the futures price is lower, short position holders pay long position holders, promoting more long positions to raise the futures price. These payments occur at regular intervals and act as a balancing force in the market, discouraging overcrowding of one market side and serving as an indicator of market sentiment. This mechanism is essential in maintaining market stability and fairness, impacting trading strategies and reflecting market trends.

1. Leverage: Trading perpetual futures contracts also provides the option of using leverage, which enables you to increase your exposure to a particular asset while using the same amount of collateral. Leverage amplifies both the potential gains and losses associated with your position.

Example 1: Consider the current price of Ethereum (ETH), which is $1550, and your belief that it’s undervalued. You have $1,000, but you think this is insufficient to fully capitalize on your high conviction and gain more exposure.

What’s your strategy? You can initiate a long position using ETH-PERP to speculate on the price of ETH going up. However, you can also apply 10x leverage to your $1,000 collateral, increasing your total collateral size to $10,000.

With this leverage, you now have a $10,000 long position on ETH-PERP. This implies that if the price of ETH increases by 1%, your position will be in profit by 10%. Conversely, if the price of ETH decreases by 1%, your position will incur a 10% loss.

It’s essential to note that if the price of ETH were to decline by 10%, your underlying position would decrease by 100%, resulting in liquidation.

1. Margin requirements: When trading, you must keep a certain amount of money in your account, known as the ‘minimum margin balance,’ to hold your positions open. If your account balance drops below this required level, you could be in for ‘liquidation.’ This means your open positions might be automatically closed to stop more losses from happening. It’s like a safety net to prevent falling into deeper financial trouble.”

2. Continuous Trading: Perpetual futures contracts enable continuous trading 24/7, allowing traders to enter or exit positions at any time, unlike traditional stock markets that have specific trading hours.

Advantages of Perpetual Futures:

1. Hedging: Traders can use perpetual futures contracts to hedge against price fluctuations in the underlying asset. By taking opposite positions in the spot market and perpetual futures, they can minimise their exposure to market volatility.

Perpetual futures serve as a valuable tool to mitigate risk associated with specific assets and shield against market turbulence. Let’s explore this concept with an example:

Example 1: Suppose you’ve purchased Ethereum (ETH) at $1555, and it currently stands at $1800. Your conviction is that ETH’s intrinsic value is $2000, and you’d rather not part with your holdings at this moment. However, you also anticipate a short-term price dip and wish to secure some profits in the interim.

What are your options? You can opt for a short position at $1800 through an ETH-PERP (Ethereum Perpetual Futures) contract to hedge your exposure to the actual ETH you own.

If the expected price dip occurs, and ETH declines to $1660, your ETH-PERP position will yield profits. This enables you to lock in gains from when ETH was at $1800, all without needing to liquidate your ETH holdings. This strategy positions you comfortably while you await ETH’s eventual ascent to your target of $2000.​

1. Speculation: Traders often use perpetual futures for speculative purposes. They can go long (betting on the price increase) or short (betting on the price decrease) with leverage, potentially increasing their profits if their market predictions are correct.

Let’s delve into the concepts of longing and shorting within the context of perpetual futures:

Longing & Shorting

• Longing: When you anticipate that an asset’s price will rise, you can choose to go long on it using perpetual futures contracts. Going long expresses your speculation that the asset’s price will increase, with the goal of profiting from this upward movement.

• Shorting: Conversely, if you believe that an asset’s price will decline, you can open a short position through perpetual futures contracts. Shorting involves speculating that the asset’s price will decrease, with the aim of profiting from this downward movement.

Example 1: Suppose you acquired Ethereum (ETH) at a price of $1550, and it currently stands at $1800. Your conviction is that ETH’s true value is $2000, and you’re not eager to part with your holdings. Nonetheless, you anticipate a short-term price dip and wish to secure some profits in the interim.

What’s your strategy? You can take a short position with an ETH-PERP contract at $1800 to safeguard your current ETH holdings. This strategy will enable you to profit if ETH’s price decreases and face losses if it rises.

For instance, if ETH’s price drops to $1660, and you had shorted it at $1800, you would find yourself in a profitable position while you patiently await your long-term target of $2000.

Example 2: Now, consider the scenario where the initial purchase price of Ethereum (ETH) was $1550, and it currently stands at $1800. However, you firmly believe that ETH’s intrinsic value is $2000.

What’s your move? You can take a long position using an ETH-PERP contract to speculate on the price of ETH. This means you will make money if the price of ETH goes up and experience losses if the price goes down.

For example, if the price of ETH rises to $2000, and you had gone long at $1800, you would have successfully aligned with your target value of $2000 while realizing a profit.

1. Liquidity and Access: Perpetual futures contracts provide liquid access to various markets and assets, including cryptocurrencies, commodities, and stock indexes. They allow traders to gain exposure to these markets without the need to own the actual assets.

2. Arbitrage Opportunities: Traders can exploit price differences between perpetual futures and the spot market through arbitrage strategies, aiming to profit from market inefficiencies.

It’s important to note that while perpetual futures offer profit opportunities, they also involve significant risks due to the leverage involved. Traders should have a thorough understanding of the market and risk management techniques before engaging in perpetual futures trading.

​​​In summary, the perpetual futures market not only offers an innovative trading mechanism but also acts as a barometer for the broader cryptocurrency market dynamics, reflecting trader expectations and market leverage conditions.