If you’ve been in the crypto industry for any length of time, you may have come across the term “perpetual swap contract.”
Perpetual swaps, or “perps,” operate in a very similar fashion to futures contracts in that they allow users to purchase or sell an underlying asset at a future date, but with one key difference – perpetual swap contracts have no expiration date.
This means a user can keep their contract to buy or sell open as long as they want – provided they keep up with margin payments – until they’re ready to settle them or sell them on to another user.
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Because these types of trading contracts have no expiration date, they require a special mechanism to ensure the contract price tracks the spot price (current market price) as close as it can. This system is known as a “perpetual swap funding rate” and essentially involves long (buyers) or short (sellers) users paying the opposite party a periodic fee, depending on whether the contract’s price is above or below the market price.
If the market price is lower than the perp futures price, long users will be required to pay a fee to short users to discourage more users going long. Conversely, if the market price is higher than the perps futures price, short users will pay a fee to long users.
Perp funding rates can often be a useful metric for gauging market sentiment around a particular asset.
It’s important to understand three key parts of a futures trade:
Margin account: This is where the initial margin is kept (the minimum amount of collateral required to open a futures trade).
Margin calls: A margin call refers to when an exchange notifies a user that the capital in their margin account is getting low.
Maintenance margin: This is the amount of funds a user must have ready to deposit into their margin account if their initial margin runs out. Think of it as a backup fund.
In the event the market goes against a user and their respective margin account is depleted, they incur something known as “liquidation” – meaning your position will be automatically closed by the exchange and your initial margin taken.
To find out how much the market has to move against you before you’re liquidated, the general formula is: Liquidation % = 100/leverage. So, for example, if you are leveraged 50x, the market only needs to move against you by 2% to liquidate your position (100/50 = 2). In the highly volatile crypto space, that means you run an incredibly high risk of being liquidated and losing your invested capital.
Of course, users can always top up their initial margins to keep their positions open for longer in the hope the market moves the other way, but, again, this adds additional capital risk.
In a nutshell, a futures contract is an agreement between two parties to either buy or sell an asset, such as digital currency, on a predetermined date, at a predetermined price. The contract tracks an underlying asset, be it a commodity, stock, or cryptocurrency. It is basically a form of bet on the future price movement.
Disclaimer:
Cryptocurrencies are subjected to high market risk and volatility despite high growth potential. Users are strongly advised to do their research and invest at their own risk. BitMart will do its best to list only high-quality coins, but will not be responsible for your investment losses.
