Perpetual Futures: Everything You Need to Know. | Credit: Shutterstock
Key Takeaways
- In perpetual futures trading, maintenance margin is a critical risk management threshold.
- Insurance funds serve as a safety net, covering losses incurred during liquidation.
- Auto-deleveraging helps prevent market disruptions when insurance funds are insufficient.
- Prudent risk management is essential to navigate the inherent volatility of perpetual futures.
Introduction To Perpetual Futures
A key element of the crypto derivatives market is perpetual futures, often known as perpetual swaps or perpetual contracts. They are a special type of financial instrument that merges perpetual trading with standard futures contracts, giving traders a number of benefits and opportunities.
Permanent futures are a type of derivative contract that lets traders make predictions about the price changes of cryptocurrencies without actually possessing the underlying assets. Contrary to conventional futures contracts, perpetual futures are perpetual in nature because they don’t have an expiration date. They use a funding method rather than an expiration date to keep their pricing close to the spot market price.
The lack of expiration, strong liquidity, and use of leverage, which allow traders to increase their positions, are important characteristics of perpetual futures. To maintain the price of the contract in line with the spot market value of the underlying asset, these contracts additionally use a funding rate that is frequently adjusted. Trading positions that are long or short can help investors gain from both rising and declining markets.
Perpetual futures have a number of benefits over conventional futures contracts. They offer ongoing trading possibilities without requiring position rollovers to traders. Furthermore, the risk associated with unexpected contract expirations is eliminated by the perpetual nature of these arrangements. The cost of holding positions can be impacted by funding rates; therefore, traders should be aware of them.
A key element of perpetual futures contracts in the cryptocurrency derivatives market is funding rates. These rates keep the price of the perpetual futures contract closely aligned with the underlying cryptocurrency’s spot market price.
How Do Perpetual Futures Work
Here are the steps to understanding how perpetual futures contracts work:
Contract Creation
Cryptocurrency exchanges or derivatives platforms construct and provide perpetual futures contracts. These contracts have no expiration date and are made to follow the value of an underlying cryptocurrency.
Funding Rate Calculation
Perpetual futures contracts use a funding mechanism to make sure their prices correspond with the price of the underlying cryptocurrency on the spot market. The financing rate is determined on a regular basis, usually every eight hours. Based on the premium or discount the contract has over the spot price, it adjusts.
Premium And Discount
Long traders fund short traders when the perpetual futures contract is trading at a premium (higher) than the spot market price, and vice versa when it is trading at a discount. This payment aids in preserving price stability.
No Expiry Date
Perpetual futures contracts do not have an expiration date, in contrast to conventional futures contracts. This implies that traders can maintain their positions for as long as they like.
Leverage
Options for leverage are frequently available with perpetual futures contracts, enabling traders to manage greater positions with a lesser amount of cash. Utilizing leverage carefully is advised because it can magnify both gains and losses.
Trading Long and Short
In perpetual futures contracts, traders may adopt long (buy) or short (sell) positions. In contrast to short positions, which profit from dropping prices, long positions benefit from rising prices.
Constant Trading
Contracts for perpetual futures offer constant trading opportunities. Without being restricted by predetermined contract expiration dates, traders are free to open and end positions whenever they choose.
Funding Sources Maintenance
The funding mechanism makes sure that the price of the contract roughly resembles the price on the spot market. Funding rates affect the price of holding positions, thus traders should be aware of them.
Risk Management
Risk management is essential while trading perpetual futures because there is a chance for substantial gains or losses. Stop-loss orders, position size techniques, and responsible risk management procedures should all be used by traders.
Exit Strategies
Based on their trading plan and the current state of the market, traders should have distinct exit strategies, such as lowering losses or capturing profits.
Ongoing Monitoring
To make wise selections and modify their tactics as necessary, traders should constantly watch the market, funding rates, and their open positions.
Liquidity Considerations
When trading perpetual futures contracts, liquidity is crucial. Make sure there is enough liquidity in the contract you are trading to allow for easy entry and exit of positions.
Perpetual Futures In The Crypto World
In the world of cryptocurrencies, perpetual futures contracts are common and are available for a number of cryptocurrencies. Listed below are a few cryptocurrencies with active perpetual futures markets:
Bitcoin (BTC) Perpetual Futures
Coinbase enables traders to make predictions about the price changes of the cryptocurrency by providing perpetual futures contracts for BTC. Depending on their expectations of the market, traders can use leverage to trade BTC perpetual futures, either going long (buying) or short (selling). A user-friendly interface for trading these contracts is offered by Coinbase.
Ethereum (ETH) Perpetual Futures
One of the biggest cryptocurrency exchanges, Binance, provides perpetual futures contracts for Ether (ETH). These contracts allow traders on Binance to trade ETH with leverage, making it simple for both seasoned and new traders to trade the ETH price.
Ripple (XRP) Perpetual Futures
The well-known cryptocurrency exchange Kraken offers perpetual futures contracts for Ripple (XRP). These contracts allow traders to make predictions about the changes in the price of XRP. With the help of Kraken’s platform, traders may vary their approaches by choosing from a number of trading pairings, including XRP perpetual futures.
Perpetual Futures Vs. Spot Trading
Leverage is used in perpetual futures trading to speculate on cryptocurrency prices, which can lead to bigger gains but also magnified losses. On the contrary, spot trading entails purchasing and maintaining actual cryptocurrencies.
Here are a few differences between perpetual futures and spot trading:
The above table compares the main features of spot trading with perpetual futures in the cryptocurrency market. Since perpetual futures have no expiration date and offer flexibility but higher complexity, traders can utilize leverage, possibly boosting gains and losses.
Spot trading, in contrast, is buying and holding real cryptocurrencies without the use of leverage or expiration dates, making it a less complicated long-term investing strategy.
Exploring Defi Perpetual Futures
Decentralized Finance (DeFi) has significantly innovated the financial sector since its debut. DeFi refers to a collection of blockchain-based programs and protocols that attempt to decentralize conventional financial services by providing public access to financial instruments like borrowing, lending, trading, and other activities.
The perpetual futures trading industry has also been impacted by this financial paradigm shift. Decentralized perpetual futures trading platforms developed by DeFi projects enable customers to employ leveraged trading while keeping ownership over their funds.
In order to construct trustless, non-custodial settings where users can trade perpetual futures without relying on centralized middlemen, these platforms frequently use smart contracts. DeFi’s composability also enables users to smoothly trade perpetual futures by utilizing decentralized assets and liquidity pools.
Decentralized perpetual futures trading is likely to remain a focal point as the DeFi ecosystem develops since it gives traders cutting-edge ways to engage in leveraged trading while supporting the ideas of decentralization and financial inclusion.
Standard Futures Vs. Perpetual Futures
Standard futures contracts have set expiration dates, call for periodic rolling, and are appropriate for longer-term hedging. Futures that never expire allow for ongoing trading, making them perfect for speculative trading. Although both provide leverage, perpetual futures do not require ongoing contract administration.
The above table contrasts perpetual futures versus ordinary futures in the trading of cryptocurrencies. Perpetual futures have special benefits for leveraged trading because they feature a funding mechanism to keep prices in line with the current market. Each type of contract is ideal for various trading techniques and goals, thanks to these distinctions.
Risk Management And Liquidation
Perpetual futures trading exposes traders to high risks, mostly as a result of leverage and market volatility, while also providing chances for huge profits. To reduce these risks, effective risk management is essential. Managing position sizes, diversifying their portfolios, and placing stop-loss and take-profit orders are all common methods used by traders.
However, liquidation becomes a reality when market changes cause losses to exceed a trader’s margin. Exchanges impose liquidation, an automatic process that closes a trader’s position to stop future losses and preserve market integrity.
The Role Of Insurance Funds
For losses sustained during liquidation, several exchanges use insurance funds. These funds, which are accumulated from the profits made by successful traders, are able to cover losses in excess of what the traders’ collateral can. Insurance funds help to keep markets stable and make sure that successful traders are not adversely impacted by liquidations.
The Significance Of Auto-Deleveraging
Exchanges use auto-deleveraging as a management tool when insurance funds are insufficient to cover liquidation losses. In such circumstances, a portion of the earnings of the successful traders with the highest leverage positions may be utilized to offset the losses of the liquidated holdings. Although auto-deleveraging should only be used as a last option, it contributes to the integrity of the perpetual futures market.
Therefore, perpetual futures traders need to be careful to monitor their positions, keep maintenance margins, and use risk management techniques to prevent liquidation. A further degree of security is offered by the availability of insurance funds and auto-deleveraging mechanisms, but careful risk management is still crucial for handling the inherent volatility of perpetual futures trading.
Conclusion
Maintaining the maintenance margin is a crucial aspect of risk management in perpetual futures trading. Liquidation may trigger if the amount drops below this threshold, protecting traders from further losses. Through the coverage of potential deficiencies during liquidation, the inclusion of insurance funds gives an additional layer of security.
To preserve market integrity, auto-deleveraging is still a last resort. Risk management measures must be given top priority by traders if they want to succeed in this high-risk, high-reward environment.
Read More: 7 Indicators To Use For Technical Analysis In Crypto Trading
FAQs
What happens if my account balance falls below the maintenance margin?
If your account balance falls below the maintenance margin in perpetual futures trading, it triggers liquidation. Your position will be forcibly closed to prevent further losses. It’s crucial to maintain a sufficient margin to avoid this situation.
How are insurance funds funded, and who benefits from them?
Insurance funds in perpetual futures trading are funded by profits generated by profitable traders on the exchange. They serve as a safety net to cover losses incurred during liquidation. All traders on the platform benefit indirectly, as insurance funds help maintain market stability.
When does auto-deleveraging come into play, and how does it affect traders?
Auto-deleveraging is employed when insurance funds are insufficient to cover liquidation losses. It affects traders with the highest leveraged positions by using a portion of their profits to cover the losses of liquidated positions. While it’s a last-resort measure, it ensures the integrity of the perpetual futures market.
What are some effective risk management strategies to avoid liquidation in perpetual futures trading?
Effective risk management includes setting stop-loss and take-profit orders, managing position sizes, diversifying portfolios, and staying informed about market conditions. These strategies help minimize the risk of falling below the maintenance margin and facing liquidation in volatile markets.
