Perpetual Contracts for Cryptocurrencies – A Beginner’s Guide
Perpetual contracts trading makes up a significant percentage of overall exchange-traded cryptocurrency volumes. Investors who are looking to bet on the price developments of BTC and other crypto assets are often not too concerned about holding actual tokens but are instead interested in trading highly liquid cryptocurrency derivatives such as perpetual futures contracts.
Perpetual futures contracts on cryptocurrencies are financial derivatives enabling traders to bet on the price movements of crypto assets using leverage without owning the underlying digital asset.
A futures contract is an agreement between two trading counterparties to buy (or sell) an asset at a specific price at a predetermined date in the future. A perpetual futures contract is effectively the same as a futures contract, with the key difference being that they have no expiry date.
The difference between the perpetual futures price and the price of the underlying asset or reference index is the funding rate. The funding rate is either paid or received, depending on whether you are short or long.
Regardless of the technical variances between trading crypto and perpetual futures, the underlying trading procedure is essentially identical, implying that any trader with a basic understanding of online trading can also trade perpetual crypto contracts.
Advantages of Perpetual Contract Trading
Since flexibility is the name of the game, perpetual contract trading is a tool that allows you to conduct both short and long trades, unlike spot trading, which is unidirectional.
Therefore, you are not stuck with a loss-making trade even in a bear market or during weekends, considering the nature of the cryptocurrency market, which has no bank holidays. The only time exchanges are not in operation is when there is scheduled maintenance, of which traders are given prior notice.
The increased leverage of perpetual contracts further improves their allure. Up to 100x leverage on perpetual contract trades are available on some exchanges. This certainly makes the potential investor profits larger, which attracts investors, but they are very risky too. The possibility of starting out little and building up your portfolio through profit maximization is the essence of perpetual contracts.
How Secure Are Perpetual Contracts?
Undoubtedly, the security of crypto exchanges is vital for the success of the digital asset ecosystem, which is why there is a growing need for impenetrable security that fosters confidence, preventing hesitation from the public.
In all this, the fact remains that blockchains are not the problem. For example, it is not economically viable to reverse BTC transactions through a majority attack due to the computing power required and the inherent protective mechanism employed by the creator. The sources of all these hacks can be zeroed in on third parties.
Exchanges’ hot wallets and users are prone to attacks such as phishing. When hackers strike, they steal not only funds but also sensitive personal data demanded in KYC, such as passport pictures, social security numbers, and home addresses. For this reason, it is imperative that the security of an exchange’s fund is collaborative.
Ultimately, the security of initial margins depends on how robust the exchange’s security is. If security is guaranteed, then trading cryptocurrency derivative products will be a resounding success. Below are some of the tactics employed by most exchanges to boost security:
- Mandatory KYC and AML procedures
- Regular third-party testing of the exchange’s security systems
- Segregation of the internal network from the web
- Wallet protection and storage of the majority of funds in cold multi-signature wallets often distributed across different geographies
- Cryptographical multifactor verification for sensitive operations
Trading Bitcoin Perpetual Contracts
Perpetual contracts for Bitcoin, also referred to as perpetual swaps, are a prevalent form of futures contract mostly dominated by BitMEX exchange.
The XBT/USD perpetual swap is one of the flagship products offered by BitMEX and is similarly provided by exchanges OKEx, Cryptofacilities, and Deribit, who are the main competitors to BitMEX in offering Bitcoin derivatives products.
BTC derivatives, predominantly perpetual swaps on BitMEX, gained enormous popularity last year, with the Chicago Mercantile Exchange (CME) and other BTC derivatives platforms all seeing record volumes in the closing months of 2019.
To help you picture the volumes involved, BitMEX has constant 24-hour BTC futures volumes of about $2 billion and saw approximately $79 billion in futures volume in May of 2019.
Perpetual swaps launched the BTC derivatives market with remarkable acclaim, mainly because of their enormous leverage. Bitcoin derivatives platforms have continued to attract a mixture of both professional and retail investors, although recent analysis by BitMEX reveals that traders often do not use the maximum leverage (100x leverage on perpetual swaps) because they have minimal success rates if they do.
More Exchanges Are Developing Perpetual Contracts
More and more crypto trading platforms are offering investors diverse ways to use leverage in order to capture perpetual contracts. One of the most prominent exchanges to do this is Liquid, a Japanese based exchange that has developed lucrative perpetual contracts with up to 100x leverage.
The BTC contract on Liquid, which was unveiled on January 27, 2020, is based on an index price referencing the real-time prices of five cryptocurrency exchanges: Bitstamp, Coinbase, Gemini, Kraken, and Liquid. The index price takes the BTC price from these five exchanges, discards the highest and lowest values, and then calculates an average between the remaining three.
Similarly, in March 2020, Singapore-based crypto futures exchange Bybit introduced the addition of Tether (USDT) perpetual contracts. By adding the stablecoin to its existing futures contracts, Bybit intends to facilitate investors with improved flexibility, as they can now hold long and short positions concurrently.
Also, on March 31, 2020, Huobi derivatives markets (DM), a trading platform that supports cryptocurrency futures and perpetual contracts, introduced perpetual swaps that allow users to hedge risk better and access leveraged arbitrage opportunities during volatile or unstable market conditions.
Ciara Sun, VP of global business operations at Huobi Group, explained that perpetual swaps offer traders yet another useful tool to help them take advantage of market movements in order to create arbitrage opportunities.
Generally, perpetual contracts don’t have an expiry date, which is an advantage over the futures market. Because there’s no expiry, speculative traders and investors alike can have a hassle-free trading environment where they can hedge and even hold trades as long as they want. Moreover, there are no added costs apart from funding costs, settled hourly, or, on some exchanges, every eight hours.
Furthermore, there is usually a possibility for leverage trading of up to 100x. Since the leverage is high, traders can open or close a position with only a fraction of their account balance. Contracts, therefore, offer the potential to make a higher return from a smaller initial outlay than investing directly in the underlying security.
As institutional funds progressively enter the crypto markets, many expect crypto derivatives products to increase and mature. Perpetual contracts represent a fascinating method for no expiry futures contracts directly in BTC and other digital assets, and their rising popularity amongst top exchanges such as Huobi and BitMEX only underlines their staying power on the broader market.