Perpetual futures are the engine of modern cryptocurrency trading, accounting for more than 90% of total cryptocurrency derivatives trading volume. But trading can seem like a volatile game – especially when you take into account leverage, spread margin and complex terminology. It’s easy to get lost in the noise.
Fortunately, you’re in good hands: BitMEX is the pioneer of perpetual futures, the contract that paved the way for modern cryptocurrency trading. If you are serious about separating yourself from amateur traders, your first step is to understand the basis of cryptocurrency trading.
TL; DR definition of perpetual futures
Perpetual futures contracts, commonly referred to as “perps” are a type of derivative agreement that enables traders to speculate on the future price of an underlying asset, without owning the asset itself. This means that criminals are always settled in cash; When a position is closed, only the resulting profits or losses are exchanged, rather than the physical asset.
If you’re coming from traditional finance, this may sound familiar, but perpetual contracts are a little different. Perps have no fixed expiry or settlement date, which means a trader can trade continuously long or short the asset indefinitely, as long as margin requirements are met.
How do perpetual futures contracts work?
Because perpetual futures are a derivative product, their value is based on the inverse of the underlying asset but is traded separately on its own market. That is, the spot price and the perpetual price of the asset can differ. Spot prices are the value of an asset that can be bought or sold for immediate ownership and delivery.
To ensure that the perpetual rate does not deviate too much from the spot rate, a financing rate mechanism is used to bridge the gap. Funding rates are small periodic payments between traders on each side of the contract (long and short) used to balance demand.
For example, if the perpetual rate is higher than the spot rate, we will need to lower the perpetual rate. A positive funding rate, which means that longs make small periodic payments to shorts, would help incentivize shorts to push the perpetual price down.
Likewise, when the perpetual rate is lower than the spot rate, financing rates will become negative. This means that short trades are now pushing long trades. This discourages selling and stimulates buying pressure, pushing the contract price up toward the spot price.
|
scenario |
The relationship of futures prices to the spot price |
Financing rate tag |
Payment flow |
Market incentives |
|
High demand over long periods |
Futures > Spot (Premium) |
Positive (+) |
Long push-up shorts |
Encourages short selling. Pushes the price down |
|
High demand for shorts |
Futures < spot price (discount) |
negative (-) |
Shorts pay long runs |
Encourages long-term purchasing. It pushes prices up |
Why do traders use perpetual futures contracts instead of spot trading? The beauty of perpetual futures is the ability to offer high leverage to amplify returns as well as directional bets (long or short). However, note that perpetual futures contracts involve a continuous market-to-market settlement system. This means that profits and losses are calculated and applied to the trader’s margin balance in almost real time. This continuous settlement is necessary to manage the high risks inherent in leveraged positions.
Key features of permanent contracts
These are the features that have cemented the cryptocurrency perpetual contract as the dominant instrument in the 24/7 market:
There is no expiration or settlement date
Unlike traditional financing, perpetual contracts do not have a fixed expiration date, allowing positions to be held indefinitely provided margin requirements are met. This simplicity eliminates the administrative overhead and transaction costs associated with rolling over traditional futures contracts before the mandatory settlement date.
High leverage
Perpetual options offer higher leverage, meaning traders can allocate a small amount of capital to control a large position. If a trader opens with a 100x leverage of $10,000, he will have to commit about $100 in margin. Traders can maximize their exposure to magnify gains – but in the same way, this comes with the risk of magnifying losses.
24/7 operation
Consistent with the continuous nature of the underlying cryptocurrency market, perpetual contracts are traded 24 hours a day, 7 days a week. This is advantageous compared to traditional markets that operate in a limited time. Traders have the flexibility to access the markets on weekends and public holidays.
Perpetuals vs. traditional futures
Let’s take a look at the main differences between perpetual and traditional futures:
|
feature |
Perpetual futures contracts (PERPS) |
Conventional futures contracts |
|
Contract expiration |
no one; Indefinite contract |
Fixed expiry date (must be settled or posted) |
|
Price mechanism |
Financing Rate dynamically locks in the rate instantly |
They are priced based on futures market expectations, and only converge at expiration |
|
Availability of financial leverage |
Generally much higher (often exceeding 10x – up to 250x on BitMEX) |
It is usually lower, but varies depending on drainage |
|
Settlement method |
Continuous, cash settlement (market to market) |
Physical delivery or financial cash settlement is required upon expiration |
|
Trading hours |
Continuous access to the markets 24 hours a day, 7 days a week |
Fixed daily trading hours (for example, 9 hours per day) |
Margin, liquidation and risk controls
Frequent traders can magnify their gains through leverage. However, leverage is a double-edged sword, as losses are also magnified. To trade effectively, traders must understand the risks associated with it and how to manage them properly.
You must meet the Initial Margin (IM) to open the trade. Where does this additional capital come from? Effectively, the exchange lends the user the necessary funds. To protect itself from losses, the exchange uses a liquidation mechanism that closes the user’s position when its margin falls below the Maintenance Margin (MM). It is better to leave some capital with as much margin as you wish to maintain the position.
To ensure that profitable traders always get paid in full, many exchanges maintain an insurance fund to cover any losses that exceed a trader’s liquidated margin, especially in times of high volatility.
Risks at a glance
While perpetual trading offers tremendous power, just like every trading product, there are elevated risks that you must manage:
Liquidation risks
High leverage significantly increases risk liquidation. It is a best practice to manage your risks properly such as using a lower capital balance and setting a stop loss to minimize loss.
Financing rate costs
Since funding rate payments are made between traders every time period (for example, every 8 hours), maintaining your position can become expensive, especially when the market becomes overheated. A best practice is to use a funding rate tracker to identify overheated periods like Coinglass.
Market fluctuations
Cryptocurrency markets are known for sudden price changes. Trading can sometimes be volatile because these highs or lows can quickly exhaust margin in a highly leveraged account. Exchanges with traders with high leverage or limited liquidity may experience greater price fluctuations.
Common uses: hedging, speculation, arbitrage
Speculation
Traders can amplify their gains through leverage in both directions – in the long and short term. Unlike spot trading, perpetual contracts allow traders to sell an asset short in anticipation of a decline in price.
Hedging
With the ability to take directional trades, a trade is able to hedge its spot position by opening a permanent short position. This allows traders to hedge against potential downside volatility and protect their portfolios.
Arbitrage
The primary feature of perpetual futures contracts is the financing rate mechanisms. Since funding rates are historically positive (meaning the long term is short), traders are able to exploit this with a delta neutral strategy. By purchasing the underlying asset and opening a permanent short position, traders can hedge price risk while receiving a periodic funding payment. This method is popular among hedge funds and arbitrage projects such as Athena.
Frequently asked questions
What is the funding rate in perpetual futures contracts?
The funding rate is the central technical innovation of perpetual contracts – a small periodic payment mechanism that is transferred directly between long and short position holders. Its primary function is to financially stimulate the perpetual futures price to remain closely aligned with the underlying spot price, effectively mimicking the price convergence found in traditional futures contracts without the need for a specific settlement date.
Why don’t Perps expire and how is the price kept around the spot?
Perpetual contracts are designed to allow traders to hold speculative or hedging positions indefinitely for superior flexibility. The fiat funding rate is the mechanism responsible for permanently fixing the cryptocurrency price near the spot price. This periodic push creates irresistible financial pressure to correct any persistent deviation in the price (basis), thus keeping the market stable and synchronized.
How often is financing collected?
The time interval for collecting and exchanging the funding price varies slightly by contract, but the industry standard used by the majority of significant cryptocurrency derivatives exchanges is every eight hours. This results in three financing payments or receipts over a 24-hour period.
What is the difference between spot price, index and perp price?
- Spot price: The current real-time transaction rate for the immediate purchase or sale of a physical asset at a particular location.
- Perp Price (Last Price): The price of the last executed trade on a selected futures exchange. It is an active trading price, but it can be very volatile.
- Index price: A crucial reference price, calculated by aggregating and averaging the spot prices of the underlying asset from several major and trusted cryptocurrency exchanges. It serves as a stable and non-manipulable baseline for pricing derivatives.
- Tag price: Estimated fair value, which is calculated using a fixed index price and is used exclusively for profit and loss calculations and liquidation initiation.
How to liquidate a leveraged PRP position?
Liquidation occurs when a trader’s position fails to meet the required minimum maintenance margin (MM) due to adverse market price movements. This process is an automatic and mandatory function of the trading platform designed to close the position before the trader’s account balance turns negative. The tick price – not the final, volatile price – is the trigger. When the tick price reaches the pre-determined liquidation price, the exchange’s risk engine automatically closes the position at the prevailing market price to cover potential losses.
