Perpetual Futures Explained
Perpetual futures, often referred to as "perps" or "perpetual swaps," are a popular type of derivative product in cryptocurrency trading
12. They allow traders to speculate on the price movements of an underlying asset, typically a cryptocurrency, without needing to own the asset itself
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Key Characteristics
Perpetual futures are distinct from traditional futures contracts due to several key features:
- No Expiration Date Unlike traditional futures, perpetual futures do not have an expiration or settlement date, meaning they can be held indefinitely as long as the trading account maintains sufficient margin to prevent liquidation 134.
- Tracking the Spot Price Perpetual futures are designed to track the price of the underlying asset in perpetuity 1. Since they lack an expiry date that forces convergence with the spot price, they use a funding mechanism to keep the futures price aligned with the underlying asset's spot price 3.
- Leverage These contracts offer leverage, which allows traders to amplify their exposure to potential gains or losses 14. For example, some large-cap assets like BTC and ETH may offer up to 20x leverage on platforms that support perpetual futures .
- Liquidity Perpetual futures are considered the most liquid derivative instrument in decentralized finance (DeFi), often accounting for more volume than their spot market counterparts 2.
The Funding Mechanism
The funding mechanism is crucial for maintaining the balance between the perpetual futures market price and the underlying reference price
1. This mechanism involves regular funding payments exchanged between long and short positions
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- How it Works If the perpetual futures price is trading higher than the spot price, the funding rate is positive, and long position holders pay a fee to short position holders 3. Conversely, if the futures price is trading lower than the spot price, the funding rate becomes negative, and short position holders pay a fee to long position holders 3.
- Purpose This system incentivizes arbitrage activities, which helps align the contract's price with the spot price, discourages market manipulation, and promotes fair price discovery 1. Price oracles are used to track the underlying asset's price for this mechanism 1.
Uses of Perpetual Futures
Perpetual futures can be used for three main purposes
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- Speculating Traders can speculate on the price movements of specific assets or markets, often utilizing leverage 2.
- Hedging They can be used to insure against uncertain price movements or asset exposure, allowing traders to lock in profits or protect against short-term pullbacks by taking a short position 2.
- Access They provide liquid access to markets and assets that might otherwise be difficult to trade, such as commodities or trading indexes 2.
This derivative model has also been applied to real-world assets (RWAs) to introduce synthetic exposure without the need for acquiring, custodying, or legally structuring the underlying assets
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