Perpetual Contracts in Crypto: All You Need To Know!
Filip Dimkovskion August 1, 2022.
If you've been around in markets like forex, stocks, or crypto for a while, you've probably heard about different types of contracts being used. Whether it's a contract for difference (a CFD), a futures contract, or a perpetual contract, they are all necessary tools to navigate the markets.
In traditional finance, perpetual contracts refer to financial derivative contracts that have no expiration date. When signing the perpetual contract, both parties agree that there will be no expiration date nor settlement details, allowing the contract to go about indefinitely.
You might ask, why have an indefinite contract? Well, there are a number of reasons why perpetual contracts are used. Namely, they offer a lot of benefits in the world of investing, as they allow traders to hold positions without an expiration—even if the position is leveraged. Traditionally, these contracts were used in the stock market and the foreign exchange market, but now, with the rise of DeFi, they have become popular in crypto too.
What Are Perpetual Contracts in Crypto?
As we mentioned above, a perpetual contract in crypto is a derivative financial contract that has no fixed expiration date or settlement. Before crypto, the most popular type of perpetual contracts were USD-denominated contracts, which are settled in US dollars. If you've used popular margin trading platforms, you've probably encountered perpetual contracts at least once. Now, there are also crypto-settled perpetual contracts, which are denominated and settled in cryptocurrencies.
Crypto-settled perpetual contracts were first introduced on BitMEX in 2016 and have since become increasingly popular. The main benefit of these types of contracts is that they allow traders to take advantage of price movements without having to actually own the underlying asset.
For example, let's say you wanted to trade Ethereum but didn't want to actually own any ETH. With a crypto-settled perpetual contract, you can trade ETH without having to hold any of the cryptocurrency—and you can do it indefinitely, as these contracts have no expiration date. Additionally, thanks to the level of development blockchain technology has reached, you could even make a perpetual contract with smart contracts. Although it's still a relatively uncharted space, there are different types of smart contracts, so legally binding smart contracts could be the future of perpetual ones.
How Do Perpetual Contracts Work?
Now that we know what perpetual contracts are, let's take a look at how they work. The key feature of a perpetual contract is that it's margined. This means that when you open a position, you will only have to put down a small percentage of the total value of the contract as collateral.
The amount of collateral you have to put down is called the margin. For example, if you're trading a perpetual contract with a 50x leverage, that means you only have to put down 2% of the total value of the contract as margin.
This is one of the main benefits of perpetual contracts—they allow you to trade with a lot of leverage, which can drastically magnify your profits. However, keep in mind that perpetual contracts do not offer risk-free returns like dApps in DeFi do. If you're looking into risk-free returns, consider researching the best dApps for making money.
Diving deeper into perpetual contracts, a key feature they have is that they use a funding mechanism to keep the contract price stable. This funding mechanism is what's known as a basis swap. In a basis swap, both parties agree to exchange the difference in interest rates between two assets.
For example, let's say you're long ETH and short BTC on a perpetual contract. If the interest rate of ETH is higher than the interest rate of BTC, you will have to pay funding to the party you're trading with. If you've read about futures, then this might sound familiar, which is why we'll now explain the differences between perpetual vs. future contracts.
The Difference Between Perpetual and Future Contracts
The main difference between these two types of contracts is that future contracts have a fixed expiration date, while perpetual contracts do not. This means that with a future contract, you will have to close your position before the expiration date—otherwise, you will be forced to take delivery of the underlying asset.
With a perpetual contract, on the other hand, you can hold your position indefinitely. This is one of the main benefits of these types of contracts—they allow you to trade without having to worry about an expiration date.
Exchanges That Offer Perpetual Crypto Contracts
There are many crypto exchanges offering perpetual contracts, but you won't go wrong sticking to big and reputable ones. Consider checking out one of the following exchanges for perpetual contracts:
Many of these exchanges also offer automated trading, where you could get into trading cryptocurrency algorithmically. If you're looking into passive income, then algorithmic crypto trading is a great choice for you.