What are perpetual futures, and how do they work? They are the cornerstone of crypto trading since they offer opportunities for high returns without the need for the underlying asset to be owned. They allow traders to speculate on asset prices indefinitely.

In this guide, we will explain the concept’s meaning, primary features, and mechanisms, as well as provide examples and trading strategies.

What Are Perpetual Futures?

Also known as perpetuals and perpetual swaps, perpetual futures are derivative contracts allowing traders to make speculative investments in the future price of an asset with no expiration date. While traditional futures contracts have a fixed expiration date, perpetual futures can be held indefinitely.

In crypto trading, perpetual futures represent a well-known financial instrument. They can speculate on Ethereum and Bitcoin perpetual futures but can also be applied to other assets such as indices and commodities.

What makes them appealing is their capacity to allow greater leverage and the ability to be more liquid compared to the spot crypto market.

What Is a Perpetual Contract?

These contracts represent a type of crypto derivative that traders can use. Even though perpetual futures resemble standard futures contracts, the key difference is that perpetual futures contracts have no expiration date.

How Do Perpetual Futures Work?

Now that you know what perpetual futures are, let’s see how they work. As the futures contract value is determined by considering a pre-agreed price on a future date (futures price), the traditional futures contract value varies from the current underlying asset price.

Suppose someone enters a futures contract today to buy BTC at $20,000 in six months. The actual BTC price will differ from the $20,000 value contract, affecting the position’s loss or profit. Speculators find these futures contract fluctuations attractive.

With the contract expiration and settlement process approaching, the futures price usually moves toward the spot price, keeping the futures and spot prices connected.

The contracts that perpetual traders open have a fixed value but no expiry date, allowing the traders to hold the contract indefinitely. So, a mechanism that ensures the two prices stay connected is needed to incentivize traders to continue speculating on market movements.

That’s especially relevant when considering inverse perpetual vs USDT perpetual, where the used collateral types may differ.

Perpetual futures markets use a system called the funding model instead of settling the contract at a specific date. This system uses a periodic fee system, ensuring that the asset’s perpetual price aligns with the spot price. Whether trading crypto assets or a gold perpetual futures contract, the funding mechanism is essential to maintaining price alignment.

When the perpetual futures pricing is above the spot price, traders who hold long positions pay a fee to the ones holding short positions, and vice versa. While this mechanism balances the market, it can lead to discrepancies in times of high volatility.

Main Features of Perpetual Futures

Let’s explore the main characteristics of perpetual futures:

  • Funding rate mechanism: It ensures the contract’s price aligns with the underlying asset’s spot price. The perpetual futures funding rate adjusts periodically, depending on market conditions, and can be negative or positive.
  • No expiry date: Since perpetual futures don’t have an expiry date, you can hold a position for as long as you need. That way, traders can speculate on the asset’s future price indefinitely.
  • Margin requirements: There are two types of margins in trading perpetual futures: initial and maintenance. The former is what you must deposit to open a position, whereas the latter represents the minimum amount needed to keep in your account to prevent a margin call.
  • High leverage: A smaller capital amount enables the control of a larger position in the market. While this can amplify gains, it can also maximize the potential for higher losses, so managing the risk is very important.
  • Market-to-market settlement: This is the daily or hourly profit and loss settlement, which adjusts your margin balance in real time. If the market moves against your position and your capital drops under the maintenance margin, you may face a margin call to top up your balance.

What Is Perpetual Future Mark Price?

The perpetual future mark price is the fair value of the perpetual contract at the current time. The last trade price and the market price can both be impacted by temporary market fluctuations and are expected to be more volatile.

At the same time, the mark price helps minimize individual price fluctuations and lowers the likelihood of selling assets at unfavorable prices. This tool is valuable against manipulative trading since it accurately reflects derivative values in extremely uncertain markets. It may also have a quicker reaction to broader market movements.

Strategies for Trading Perpetual Futures

There are four primary strategies for perpetual trading:

  • Trend following: Using technical analysis, traders can identify market trends and open short or long positions accordingly. That includes following the market’s momentum, opening a position in the trend’s direction, and exiting once the trend changes.
  • Speculation: This is a high-risk strategy with the potential for high rewards, requiring careful analysis and risk management. It involves taking a short or long position in a perpetual futures contract, depending on your expectation of the underlying asset’s future price direction. For instance, understanding market trends and speculation can be a powerful approach when looking for the best way to trade Bitcoin futures.
  • Arbitrage: To make a profit, traders can exploit price differences between the spot market and the perpetual futures market by using a strategy called arbitrage. Traders do this by purchasing the asset in one market and immediately selling it in the other.
  • Hedging: You can use perpetual futures to hedge an existing position in the underlying asset. For instance, a trader who holds BTCs can sell perpetual futures to safeguard against a price that may drop.

Perpetual Futures Example

Let’s say a trader wants to speculate on Ethereum’s price using a perpetual futures contract. The trader chooses to buy one Ethereum perpetual futures contract valued at $2,000 and uses a 5x leverage, leading to a total position size of $10,000. With a margin requirement of 5%, the trader must keep $500 as collateral in their trading crypto account to open positions.

This Ethereum perpetual futures crypto contract has a funding rate of 0.03% for every 8-hour funding period. If Ethereum’s price rises to $2,500, the trader also earns $25,000 on their position. Yet, they also face a 0.03% funding fee every 8 hours, deducted from their trading account.

Vice versa, if Ethereum’s price drops to $1,500, the trader can expect a $500 loss on their position, which can also be deducted from their day trading account.

Perpetual Futures vs Standard Futures

Feature Perpetual Futures Standard Futures
Price Tracking Tracks spot price closely  Can differ from the spot price
Expiry Date No expiration date Fixed expiration date
Expiration and Rollover No expiration or rollover requirement A rollover requirement before expiration
Funding Fees Periodic funding for spot price alignment Not applicable
Liquidity Higher liquidity because of the no-expiration  Lower liquidity in some contracts
Long-Term Holding Perfect for longer-term positions The expiration makes it not ideal for longer-term holding
Trading Flexibility  Ongoing trading with no expiration  Traded on many expiration dates

There are several differences between standard and perpetual futures, with the key difference being that perpetual futures have no expiry date.

Standard futures contracts are priced depending on the forward-looking market price of the underlying asset and can be settled financially or physically. Then again, perpetual futures trade close to the underlying asset price, can be held indefinitely, and don’t expire or settle.

Are Perpetual Futures Regulated?

Perpetual futures regulation varies depending on the perp exchange and jurisdiction offering the product. In the US, regulatory authorities such as the Commodity Futures Trading Commission oversee perpetual futures.

Still, many crypto exchanges providing perpetual futures are based in other jurisdictions with less strict regulations. Traders must adhere to the regulatory landscape of the platform they use, ensuring compliance with local laws.

Conclusion

So, what are perpetual futures? They are derivative contracts allowing traders to make speculative investments in the future price of an asset with no expiration date. Its main features are the funding rates for perpetual swaps, no expiration, high leverage, margin requirements, and market-to-market settlements.

Perpetual future mark price is the fair value of the perpetual contract at the current time. The primary strategies for trading perpetual futures include arbitrage, trend following, hedging, and speculation.

When comparing standard and perpetual futures, the key difference is that perpetual futures have no expiry date. Perpetual futures regulation varies based on the exchange and jurisdiction offering the product.