What’s All the Fuss About Cryptocurrency Perpetual Contracts? Here’s a Complete Guide
When the week started, Binance Futures announced that the platform was launching XRP Perpetual Contract. Considering Binance’s dominance in the crypto space, most people have been alarmed what that could mean to Ripple’s progress in the industry. Being unacquainted with comprehensive knowledge of what Perpetual Contracts are, such wary thoughts are bound to come up.
It is no doubt that the world of cryptocurrency is rapidly evolving, continuously becoming more diverse and sophisticated. Most people have always found it tough to grasp all the technicalities involved with cryptocurrencies. Worse, right when you thought you have a hang of it and want to try crypto trading, new semantics come to light (or put you in the dark), and you have to start a new chapter of your learning process.
Well, as an industry that is still growing and has immense untapped potential, learning all the ropes of crypto trading is a must-have knowledge you should have under your sleeve. However, despite crypto being new in Fintechville (fintech sector), the volatility of its market has led to new products (trading features) being unveiled.
For instance, centralized exchanges have made it easier and more risk-free to trade thanks to several products such as crypto derivatives, marginal trading, futures contracts as well as advanced order types. And now, a recently unveiled product that seems to be trending in the crypto sector, which has even been launched by Binance and OceanEx is Perpetual Contracts.
In this article, the team at WiseCryptos has studied everything there is to know about perpetual contracts. We have explained all the details in Layman’s, in a way, both beginners and experts in crypto trading can gain insight and utilize it to the best of their understanding.
Perpetual Contracts Explained in a Nutshell
For beginners, the word “perpetual” denotes “everlasting” or “eternal”. A Perpetual Contract refers to a modification of Futures Contract with some key additional features. Futures contract entails an obligation to buy or sell an asset in the future at a predetermined price. The main difference between the two is that perpetual contracts don’t have a specified termination date. A perpetual contract is basically a hybrid of Spot margin-trading and Futures trading with the below four main characteristics discussed below.
- No Expiry Date- Unlike spot trading and futures contracts which require immediate settlement on a specified date, perpetual contracts don’t have an expiry date. Crypto traders are therefore provided with a hassle-free trading environment. In addition to no expiry date, perpetual contracts also don’t come with settlement fees and rollover costs. A funding fee is charged for holding a position. The lack of expiry dates makes perpetual contracts ideal for speculative traders and traders who perform trade hedging since they can buy/sell the positions and hold them for as long as they need.
- Dual Price Mechanism- Most perpetual contracts come with dual price mechanism to prevent market manipulation. Market manipulation is the act of knowingly inflating or deflating crypto prices on an exchange for personal gains. The abnormal fluctuations in price usually result in an unfair trading environment by causing mean liquidations on traders’ positions. Dual price mechanism that comes with perpetual contracts function to protect traders from market manipulations that can lead to hefty losses.
- Margin or Leverage Trading up to 100x- Futures contracts allow 5-20x leverage while spot margin market leverage is typically 3-5x. Perpetual contracts allow up to 100x leverage will enable traders to open or close a position with only a fraction of their account balance. With perpetual contracts, traders can make higher returns from a smaller market entry that may not be possible when directly investing in the underlying security. Perpetual contracts are, therefore, a highly flexible form of risk management and ensure the best possible trading experience.
- Safe liquidation and protective anti-manipulation mechanism- This feature apply in some exchanges such as the Xena Exchange. For transparent trading, the prices of perpetual contracts are determined by market supply and demand rather than the market platform itself, which is vulnerable to manipulation. Also, in maintaining market transparency, trading is carried out using an open book order where perpetual contracts are executed in a timely manner based on the time and priority.
Mechanics of a Perpetual Contract Market
There are several mechanisms involved in a perpetual contract market, and every crypto trader should be well-aware of. Key mechanics of a perpetual contract market are:
- Position Marking- Perpetual Contracts are position marked based on the Fair Price Marking method. The Mark Price determines Unrealized PNL and liquidation prices.
- Initial and Maintenance Margin: These are key margin levels used to establish how much leverage one can trade with and at what point market liquidation comes about. Initial margin refers to the minimum value a trader must pay to open a leverage position while maintenance margin is the minimum amount of collateral you must hold to keep trading positions open.
- Funding: Funding refers to a series of continuous payments that are exchanged between longs and shorts in a perpetual contract to peg the price of the contract to the underlying index. The funding rate is always equal to the difference between the mark price and the underlying index price. Funding is usually regarded as an 8-hourly interest rate and is computed and exchange every minute. Every time the funding rate is positive, the longs pay shorts. The vice-versa is also true. Traders only pay or receive funding if they hold a position at the Funding Timestamp.
Funding is calculated as: Funding=Position Value x Funding Rate.
- Funding Timestamps: Funding occurs every 8 hours at 04:00 UTC, 12:00 UTC, and 20:00 UTC.
The Difference between Bitcoin Perpetual Contracts and Bitcoin Futures
As earlier stated, Futures refers to an obligation to buy or sell an asset in the future at a predetermined price. A buyer is supposed to buy the underlying asset at a specific price once the contract expires. On the other hand, a seller is required to furnish the asset at the time of expiry. Bitcoin futures are quite common in the crypto space and allows traders to speculate on the future prices of Bitcoin to make enormous profit margins. Nonetheless, Bitcoin’s perpetual contracts have started becoming increasingly common in the crypto market due to the benefits they offer. Bitcoin perpetual contracts, also referred to as perpetual swaps, have been launched by various exchanges such as BitMEX, OKEx, Cryptofacilities, bitFlyer, and Deribit. Perpetual contracts are a unique form of futures contracts referred to as “inverse futures contract” There are some key differences between Perpetual Contracts and Bitcoin Futures. The major difference is that in Bitcoin Perpetual Contracts, the USD is interpreted as the commodity, while BTC represents the settlement of the contract (P/L).
Benefits of Perpetual Contract Trading
Perpetual Contract Trading is very beneficial as traders get a chance to conduct both short and long trades due to flexibility. This is unlike spot trading, where trading is unidirectional. Perpetual contract trading is also great as traders are not stuck with a loss-making trade even in a bear market or during weekends, considering the volatile nature of the cryptocurrency market.
Perpetual contracts enable investors to trade cryptocurrencies against fiat pairs without actually having exposure to the fiat. This allows investors to bypass numerous regulatory obstacles that involve fiat deposits on exchanges and limits their ability to offer various functionality. Perpetual contracts are also ideal for traders looking to hedge positions in USD by opening short trading positions.
Also, with increased leverage up to 100x of perpetual contracts enhances the profitability of crypto trading while still lowering the risk associated with crypto trading.
For crypto trade beginners, the notion of starting out with a small capital and developing your portfolio via profit maximization leveraging perpetual contracts is one way to get the best out of crypto trading. The increased leverage offered by perpetual contracts attracts investors to invest in cryptocurrency in turn enhancing the adoption of cryptocurrency and also the blockchain technology.
In the past year, there has been a surge in the launch of Perpetual Contracts in the cryptocurrency space with the Chicago Mercantile Exchange (CME) and other Bitcoin derivatives platforms (i.e., BitMEX) all citing record or near-record volumes in the last few months. It’s without a doubt that perpetual contracts offer many benefits compared to futures contracts and presents an intriguing method for trading cryptocurrency without the worry of expiry. The growing popularity of perpetual contracts among several exchanges is a key indicator of their superiority as well as the benefits they do offer. But again, it’s up to you to choose the best trading feature (options) that best suits your trading benefits. Trade safely!
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