What Are Perpetual Futures?
Perpetual Futures: An In-depth Analysis
Last updated
Perpetual Futures: An In-depth Analysis
Last updated
Cryptocurrency trading has introduced a myriad of financial instruments and one, in particular, has garnered considerable attention - perpetual futures. Also known as perpetual swaps or perps contracts, these derivatives present potential opportunities and risks for traders in equal measure. Here, we unravel the intricacies of this derivative instrument.
Perpetual futures, operating under several monikers including perps and perpetual swaps, are derivative contracts whose value is based on an underlying asset. A key distinction from spot trading is that perpetual futures permit traders to speculate on asset price fluctuations without the necessity of owning the asset itself.
Consider assets like Bitcoin (BTC), Ether (ETH), and Polygon (MATIC) - these would each have their corresponding perps contracts, denoted as BTC-PERP, ETH-PERP, and MATIC-PERP, respectively.
The trading of perps entails the opening of long and short positions by the trader. The former position is adopted when a trader expects an increase in the asset's price, while the latter is taken when the trader anticipates a price decrease.
As a prerequisite to trading perps, traders must provide collateral, either as stablecoins or as the underlying asset. This collateral determines the margin ratio - the ratio of collateral necessary to keep a perps position open. It's a critical factor in determining the extent of leverage available and the level of liquidation. If the margin falls below the required minimum, liquidation ensues.
Collateral provision is directly proportional to the margin ratio, and consequently, the degree of leverage attainable. Leverage affords increased exposure from the collateral offered. For instance, a collateral of 1 ETH could open a long position on ETH-PERP with 10x leverage, rendering a notional trade size of 10 ETH. Therefore, a 1% increase in ETH price yields a 10% gain on the collateral. However, a corresponding risk exists - a 10% drop in ETH price results in liquidation.
Perps contracts employ funding rates to ensure parity between the perps price and the price of the underlying asset. Funding rates offer incentives for arbitrageurs to rectify price discrepancies. Depending on whether the perps contract price is at a premium or discount compared to the underlying asset price, the contract’s funding rate may be positive or negative.
Speculation is a common practice among traders, leveraging perps to guess the price of the underlying asset and augment exposure. For example, a 5% increase in ETH price could yield a profit of $750 with spot trading, while the same increase could net a profit of $7,500 with perps, thanks to 10x leverage. However, the inherent risk is also magnified tenfold.
Hedging is another application of perps, offering a means of reducing exposure. For instance, owning 10,000 MATIC and shorting an equivalent amount on MATIC-PERP could offset potential losses if the price of MATIC decreases.
Arbitrage involves exploiting market inefficiencies for profit. Traders may find opportunities in perps through price discrepancies or funding rate differences between different exchanges.
Despite offering potentially higher profits than spot trading, perps contracts come with elevated risks and require careful consideration of various factors. Thus, traders need a reliable platform that blends performance with low fees for optimal perps trading. Enter IDEX, merging centralized exchange-like performance with decentralized exchange-like security. For more information, visit idex.io.
