What are Cryptocurrency Perpetuals?
Last Update: March 8th, 2022
Perpetual contracts are types of derivatives agreements with no expiration date. The contracts are similar to futures in that they let the user speculate on the price movements of an asset. In the process, a user must incur funds kept as collateral to open a position. If the price of the asset moves in favor of the investor’s position, they get a profit when the position is closed. However, if it is unfavorable, the subscriber will receive fewer assets. Different from futures, an investor can hold their position indefinitely in perpetuals.
How Do Perpetual Contracts Work?
To illustrate how perpetual contracts work, let’s say the price of bitcoin is $37,000, and investor A thinks it will rise next year. The investor can open a bitcoin perpetual futures contract to buy the asset at $37,000 in the future. If the price rose to say $47,000 in a year, the investor would profit by buying the asset at $37,000. If the reverse happens, the investor will lose.
Similarly, a short position can be taken when an investor projects that the asset would drop in value. In our example, another investor, B, believes that bitcoin would drop in value below $37,000. They can enter into a perpetual bitcoin contract by committing to sell bitcoin at the current price at a future date. If the investor is right and the price drops, they would be profitable, and the reverse is true.
Cryptocurrency Perpetual vs. Traditional Futures
While the traditional futures focus on the commodities and financial instruments as the underlying asset, in cryptocurrency perpetual, the underlying assets are the cryptocurrencies. Cryptocurrency perpetual is becoming popular in DeFi because it enables traders to hold a high leverage position with no expiry time.
In traditional futures, the contract’s price moves towards the spot market of the asset involved. In a perpetual contract, a premium known as a funding payment must be paid by traders to maintain the price in relation to the spot market. The payment is executed in that the trader holding a long position would make a funding payment to that one holding a short position if the price jumps above the spot price.
Both traditional futures and crypto perpetual have a predetermined position in a given asset, short or long. Traders enter both markets to speculate on an asset’s price and hedge against risks. Aside from the similarities, while cryptocurrency futures are offered in a cryptocurrency exchange, traditional futures are executed in a conventional exchange. The cryptocurrency futures market is relatively smaller compared to the conventional market. The former is characterized by private players, while the latter attracts large institutions and individual investors alike.
Besides, while the traditional futures markets are regulated, the cryptocurrency perpetual market is largely unregulated. The regulations, that ensure that every trade is free from fraud and is legit, tend to slow down settlements in the traditional market compared to that of digital assets. Different from future markets, the cryptocurrency market is open throughout for investors to capitalize on random price changes.
BTC Perpetual Futures
BTC perpetual futures are binding agreements to buy or sell bitcoin. An investor can enter into a bitcoin perpetual future to hedge against the asset if they think it has entered into a bear market. The investor can earn a return by taking a short position while avoiding near-term losses. With leverage, an investor can hedge the whole amount of their bitcoin holding if they expect the market to dip further.
ETH Perpetual Futures
ETH perpetual futures are contracts where the underlying asset is ether. The contract price is proportional to that of the ether token. The seller or the buyer can hold their position indefinitely in the ETH perpetual contracts. The perpetual future takes place depending on the price of the underlying asset. The index price is determined based on the average price of ether, factoring in the trading volume at the given price.
ETH perpetual contracts, like all other futures, have two categories of margins. Initial margin and maintenance margin. The initial margin refers to the minimum amount a trader must have to open a leverage position. A user can trade more than they are eligible for by depositing collateral in place of the margin amount. Maintenance margin is the minimum balance in a margin account.