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Perpetual contracts are a form of derivatives that allow traders to buy or sell the underlying asset at any random point of time in the future. This is what primarily separates perpetual futures contracts from traditional futures, as the former does not have any predetermined delivery date. This lets traders hold leveraged positions for any length of time.
Perpetual contracts also differ from futures since the former’s price stays close to the reference Index Price. This Index Price is the average value of the underlying asset, which is set in accordance with the trading volume and price of the asset in major markets. This sort of funding mechanism ensures that the value of perpetual contracts doesn’t fluctuate much, unlike futures, which can trade at significantly varying prices.
What Are Crypto Perpetual Contracts?
Over the past few years, cryptocurrency trading has exploded. The total market value for all cryptos in circulation crossed $2 trillion in 2021. This incredible success has snowballed to give rise to a full-fledged alternate economy consisting of decentralized finances. That means you can now trade crypto options, crypto futures, and crypto perpetual contracts. In fact, cryptocurrencies are the first asset class that has made the use of perpetual contracts possible, even though the concept was introduced three decades ago.
Simply put, crypto perpetual contracts or perpetual swaps are just like regular perpetual contracts, but the underlying assets are cryptocurrencies. The defining feature of crypto perpetual contracts is the availability of sky-high leverages of up to 100 times the margin. Additionally, swap markets use insurance funds and auto-deleveraging to prevent traders from going bankrupt in times of high volatility.
How Do Crypto Perpetual Contracts Differ from Regular Crypto Trading?
In general, if you want to earn a profit from cryptocurrencies, you have two routes. The first one is regular trading. This is where you go to a spot exchange and buy some, say, bitcoins. You then get to own these bitcoins and hold onto them for however long you want. When prices rise sometime in the future, you can sell them and earn yourself a profit.
The second option is crypto perpetual futures trading. Futures trading allows well-researched traders with knowledge about the future direction of the market to bet on its outcome. Perpetual futures can be bought from any DeFi marketplace.
Using this mechanism, you never actually “own” any bitcoins. What you do get is the benefit of leverage. Perpetual contracts do not require you to post 100% of your collateral as margin. This means, with the amount of money you have, you can contractually buy quite a lot more bitcoin futures than you could have as a spot market trader.
Another benefit of owning crypto perpetual contracts is that, unlike futures, there is no hassle of contending with expiration dates. Theoretically, you can hold a perpetual swap forever. It is common advice within the crypto space to “HODL” your coins for as long as possible, and futures is the perfect mechanism for doing just that.
Lastly, the price of crypto perpetual futures never deviates much from the price of the underlying coin. This is made possible using a “funding rate mechanism,” which adjusts perpetual swap demand amongst buyers and sellers.
What Are “ Funding Rates”?
The funding rate is the mechanism by which the price of perpetual contracts is stabilized. Basically, a value is assigned to any fluctuations that occur between the price of the contract and the asset, and premiums are charged, or rebates are offered accordingly to traders.
If a swap is steadily trading higher than the target price, then it signifies that the market is bullish and profitable for long position holders. During such times, the ones holding long positions provide funding to the short traders. In turn, when a perpetual swap is trading under target price, shorts are more desirable, and so, short holders fund long position holders.
The funding rate of perpetual contracts depends on the interest rate of your platform and the premiums that you may have to pay. The interest rate is a predetermined percentage cut charged by the merchant, whereas the premiums vary with respect to the difference between the price of an asset and the swap.
What Are Insurance Funds?
Insurance funds are made of collateral taken from liquidated traders to ensure that accounts holding long positions don’t go bankrupt. For some reason, if the price of an asset drops dramatically and long positions aren’t closed in due time, insurance funds ensure that the trader’s balance doesn’t become negative. The trader will lose all collateral, but the fund will cover further downfalls while ensuring that people holding short positions get their profits.
What Is Auto-deleveraging?
Auto-deleveraging is the last line of protection against bankruptcy, put in place for those times when insurance funds run out. By this mechanism, the most profitable traders delegate a portion of their profits to cover the losses of those in the red. Such counterparty liquidation is not desirable but necessary in times of high volatility. In any case, auto-deleveraging ensures that no one in the market loses absolutely everything.
Conclusion- Why Should You Be Interested in Crypto Perpetual Contracts?
Perpetual contracts are the best way for seasoned traders to earn much more from the crypto market than via regular trading. By virtue of having leverage and no expiration date, perpetual swaps can be held forever and only liquidated when your position has reaped profits. Currently, the swaps market is booming as several large businesses and governments have joined the crypto train. So now is a great time to invest in crypto derivatives and grow your portfolio by taking part in the biggest technological revolution of the decade.