As the cryptocurrency industry continues to expand and evolve, so does the world of derivatives trading. One of the newest offerings on this front is perpetual futures contracts - a hybrid contract featuring elements from both traditional futures and spot markets - allowing investors to speculate on long or short positions with reduced risks. But before you dive in headfirst, it’s important to have a firm understanding of how these complex products work. Here we explore what perpetual contracts are, their key attributes, and why they may be appealing to traders looking for leverage without expiry dates or settlement periods.
Contents of the article:
What are perpetual futures contracts?
A futures contract is an agreement between two parties to buy or sell an asset at a predetermined price and date in the future. These assets can range from commodities such as gold or oil, to financial instruments like cryptocurrencies or stocks. This type of contract serves as a powerful tool to both protect against potential losses and to secure profits.
Perpetual futures contracts are a type of derivative that allows traders to speculate on the future price of an underlying asset without actually owning it. Unlike regular futures contracts that have a set expiration date, perpetual futures contracts do not expire. This means that traders can hold their positions for as long as they want, allowing them to take advantage of long-term market trends and potentially earn significant profits. Additionally, perpetual futures contracts often have unique features like funding rates, which help keep their price in line with the underlying asset.
Perpetual futures do not have settlement periods. You can hold a trade for as long as you want, as long as you have enough margin to keep it open. For example, if you buy BTC/USDT perpetual at $30,000, you will not be bound by any contract expiry time. You can close the trade and secure your profit (or take the loss) when you want. Trading in perpetual futures is not allowed in the U.S. But the market for perpetual futures is sizable. Almost 75% of cryptocurrency trading worldwide last year was in perpetual futures.
Overall, perpetual futures contracts can be a useful tool for traders looking to gain exposure to the cryptocurrency markets, but they also come with significant risks and should be used with caution.
What are the main features of perpetual futures contracts trading?
While perpetual futures contracts are relatively new to the trading world, they have quickly gained popularity among traders looking for a flexible and versatile way to engage in speculative trading. Whether you are a seasoned trader or just starting out, perpetual futures contracts are definitely worth learning more about.
Initial margin is the minimum amount of funds required to be deposited into a trading account to open a new position. This margin is used to ensure that traders can meet their obligations if the market moves against them, and it also acts as a buffer against volatile price movements. While initial margin requirements vary between exchanges, they typically represent a fraction of the total trade value. Therefore, it is crucial to manage initial margin levels carefully to avoid liquidation or margin calls. It is also advisable to keep track of the margin requirements and regulations on different platforms to optimize your trading experience.
Maintenance margin is the minimum amount of funds that an investor must maintain in their account to keep their position open. In simple terms, it is the amount of money required to hold a position in a perpetual futures contract. This is done to protect both the exchange and the investor from potential losses. If the investor fails to meet the maintenance margin, then the crypto derivatives exchange may close their position or take other actions to ensure the remaining funds are sufficient to cover the losses.
Liquidation refers to the process of closing out a trader’s position when their available margin falls below a certain threshold. The purpose of liquidation is to mitigate risk and ensure that traders do not lose more than they can afford. For traders, it’s important to keep a close eye on their margin levels to avoid being liquidated. On the flip side, liquidation can present an opportunity for other traders to capitalize on a price drop by buying in at a lower price.
Funding rate is a mechanism for ensuring that the price of the perpetual futures contracts reflects the underlying price of Bitcoin. When the funding rate is positive, long positions pay shorts, while when it’s negative, shorts pay longs. Understanding funding rates is essential as it can impact an investor’s profit and loss, making it crucial to keep an eye on funding rates when trading perpetual futures (such as perpetual bitcoin futures, perpetual ether futures).
Mark price refers to the fair value price of an asset, which is estimated by taking into account the bid and ask prices from different trading platforms. This price is used to prevent market manipulation by ensuring that the futures contract’s price remains in line with the underlying asset’s price. This means that if the market price of cryptocurrency changes, the mark price of the futures contracts will also adjust accordingly, which can help you make more precise trading decisions.
PnL stands for “profit and loss,” and it’s a way of measuring the potential gains or losses that traders can experience when buying and selling perpetual futures contracts (such as perpetual bitcoin contracts, perpetual ether contracts). Essentially, PnL is a calculation of the difference between the entry price and the exit price of a trade, taking into account any fees or funding costs associated with the contract.
Insurance fund in perpetual futures (such as perpetual BTC contracts, perpetual ETH contracts) serves as a protection pool that helps safeguard traders against potential losses due to sudden market fluctuations. In other words, if the market experiences a sudden and unexpected drop, the insurance fund acts as a buffer to help cover any losses and prevent traders from having to liquidate their positions. It’s an important safety net in what can be a volatile and unpredictable market, and is just one of the ways that trading in perpetual futures is evolving to meet the needs of its users.
Auto-deleveraging is essentially a risk management mechanism that ensures that trading positions are closed in case of insufficient margin funds. In simpler terms, it means that if a trader’s position moves against them and their margin balance falls below the required maintenance, the crypto derivatives exchange will automatically deleverage their position. While this may sound like a bad thing, it’s actually a preventative measure that protects traders from losing more funds than they can afford. It’s important for anyone trading perpetual futures (such as perpetual bitcoin futures contracts, perpetual ether futures contracts) to understand how auto-deleveraging can affect their positions and to use it as an opportunity to assess and improve their risk management strategies.
How do perpetual futures contracts work?
Let’s take a hypothetical example to understand how perpetual futures work. Assume that a trader has some BTC. When they purchase the contract, they either want this sum to increase in line with the price of BTC/USDT or move in the opposite direction when they sell the contract. Considering that each contract is worth $1, if they purchase one contract at the price of $50.50, they must pay $1 in BTC. Instead, if they sell the contract, they get $1’s worth of BTC at the price they sold it for (it still applies if they sell before they acquire).
It is important to note that the trader is purchasing contracts, not BTC or dollars. So, why should you trade crypto perpetual futures? And how can it be certain that the contract’s price will follow the BTC/USDT price?
The answer is via a funding mechanism. Users with long positions are paid the funding rate (compensated by users with short positions) when the contract price is lower than the price of BTC, giving them an incentive to purchase contracts, causing the contract price to rise and realign with the price of BTC/USDT. Similarly, users with short positions can purchase contracts to close their positions, which will likely cause the price of the contract to increase to match the price of BTC.
In contrast to this situation, the opposite occurs when the price of the contract is higher than the price of BTC - i.e., users with long positions pay users with short positions, encouraging sellers to sell the contract, which drives its price closer to the price of BTC. The difference between the contract price and the price of BTC determines how much funding rate one will receive or pay.
What are the differences between perpetual futures contracts and traditional futures contracts?
Perpetual futures contracts and traditional futures contracts are two variations of futures trading that bring different advantages and risks to traders and investors. Unlike traditional futures contracts, perpetual futures contracts do not have a set expiry date, which allows traders to hold positions for as long as they want. Secondly, perpetual contracts offer greater flexibility and liquidity in terms of margin requirements and funding costs. Moreover, perpetual futures contracts use innovative mechanisms like funding rates to ensure that the futures price closely tracks the underlying asset’s spot price. However, perpetual contracts also come with unique risks, such as funding costs that can fluctuate as frequently as every 8 hours. Conversely, traditional futures contracts have a fixed expiration date and may require higher margin requirements, which can limit a trader’s flexibility and add uncertainty. Ultimately, which contract to use depends on a trader’s risk tolerance, trading goals, and market conditions.
What are the differences between perpetual futures contracts and margin trading?
- Timeframe: Perpetual futures contracts do not have an expiration date, while margin trading is typically done over a shorter timeframe, with traders borrowing funds to open a position for a specific period of time.
- Settlement: Perpetual futures contracts settle based on the index price of the underlying cryptocurrency, while margin trading settles based on the price of the cryptocurrency at the time the position is closed.
- Leverage: Both perpetual futures contracts and margin trading allow traders to use leverage to increase their exposure to the markets. However, perpetual futures contracts typically offer higher levels of leverage than margin trading, which can increase both potential profits and potential losses.
- Fees: Perpetual futures contracts typically have a funding fee that is paid by traders who hold their positions open for an extended period of time. Margin trading, on the other hand, typically involves paying interest on the borrowed funds.
- Collateral: Perpetual futures contracts require traders to deposit a certain amount of cryptocurrency as collateral to open a position, while margin trading requires traders to deposit funds as collateral.
How to trade futures contracts on XT.COM?
At XT.COM crypto derivatives exchange, we provide Bitcoin futures trading via two flagship products: Perpetual Bitcoin Futures and Quarterly Bitcoin Futures. These two contracts differ based on two primary factors: Expiration and Funding Fees.
Trading crypto derivatives contracts on XT Futures is simple for all traders. If you’re already a user, follow these steps to get started:
- Open a futures trading account and enable 2FA verification to fund your futures account and start trading.
- Deposit funds to your futures wallet, which supports various cryptocurrencies including USDT.
- Choose between the two derivative contracts on XT Futures - USDT Margined Futures and COIN Margined Futures.
- Select the right leverage amount for your position.
- Place an order from a range of available options - buy-limit, buy-market, and more.
Practice trading in real-time with zero risks. XT crypto derivatives platform provides a dedicated DEMO trading environment for users to learn and sharpen their skills. Join the world of crypto derivative contracts today and sign up for XT Futures now!
About XT Futures
XT.COM crypto derivatives platform offers some of the best features available on the market. With USDT-margined perpetual and quarterly contracts, as well as coin-margined perpetual and quarterly contracts and prediction markets, you’ll be able to access easy, fast trades. Plus, with copy trading, futures grid trading and more advanced tools at your disposal, the possibilities are endless. Our platform strives to cater to our large user base by providing a secure, trusted and intuitive trading experience.