Perpetual Futures and Swaps in Crypto & Investing

By Mike Zaccardi, CMT, CFA · April 12, 2022 · 5 minute read

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Perpetual Futures and Swaps in Crypto & Investing

Perpetual futures and perpetual swaps are very similar derivative agreements. Both instruments provide exposure — either long or short — to an underlying asset or index. And both perpetual swaps and perpetual futures can be used in traditional stock market investing and in cryptocurrency trading.

In this article, we’ll outline these asset types, how they work, and the pros and cons of each.

What Are Perpetual Futures?

A perpetual contract is a specific type of futures contract that does not have an expiration date. A futures contract is an agreement between a buyer and seller to transact an underlying asset or index at a specified time and price. Futures are exchange-traded, meaning if you hold a futures contract, your counterparty is the exchange, not another individual trader.

With a perpetual futures contract, on the other hand, you can own it indefinitely to have exposure to an underlying asset or index. Perpetual futures contracts are also found on different types of crypto.

What Are Perpetual Swaps?

A swap is a derivative contract in which one party exchanges cash flows on one asset for another. With swaps, your counterparty is often another trader, so there can be counterparty risk to consider with these over-the-counter (OTC) instruments.

While a futures contract obligates a buyer to purchase an asset at a specific price and time, a swap obligates two parties to exchange future cash flows on an asset or index.

How Do Perpetual Futures Work?

The holder of a perpetual futures contract can keep it for however long they would like. The futures contract can be settled with physical delivery of the underlying asset or with a simpler exchange of cash.

Perpetual crypto futures tend to track the spot market quite closely, which might appeal to crypto traders. A risk is that the price of a perpetual futures contract might stray from the spot price during market volatility (this is known as basis risk).

Pros and Cons of Perpetual Swaps

Perpetual swap contracts have become popular with crypto traders. This type of crypto swap allows traders to buy or sell an underlying asset without an expiration. The physical asset is not traded, and the perpetual swap price typically tracks the underlying asset closely. You can also short cryptocurrencies with a perpetual swap.

Perpetual swaps are new compared to standard swaps. If you have no interest in transacting physical cryptocurrency, perpetual crypto swaps may be a good choice. You may also avoid potential high basis risk that comes with futures.

Pros of a Perpetual Swap

Cons of a Perpetual Swap

There is no expiration There are funding rate costs
You can trade with a high degree of leverage Losses are amplified when trading with leverage
Liquidity is typically high There can be counterparty risk with swaps

Margin Requirements for Perpetual Futures

There are two margin requirements when trading crypto perpetual futures and swaps: initial margin and maintenance margin. A swap also has different margin requirements than a futures contract—specifically, there are no margin calls.

The following terms also apply to many futures markets.

Initial Margin

Initial margin is a good faith deposit that acts as collateral to open a leveraged futures or swaps position.

Maintenance Margin

Maintenance margin is the minimum amount of equity you must hold to continue owning open positions. If your equity falls below the maintenance margin requirement, you will receive a margin call or your crypto account will be liquidated. Your maintenance margin amount will fluctuate with market prices and the amount of your collateral.

Recommended: What’s The Difference Between Margin and Futures?

Perpetual Futures Terms

There are several important perpetual futures terms to know. Let’s dive into what each means in the crypto trading derivative markets.

Liquidation

Liquidation happens when your crypto futures account value drops below the maintenance margin requirement and the exchange or broker automatically sells your long positions or covers your short positions. You can avoid liquidation by closing positions or depositing more funds.

Funding Rate

Since perpetual futures do not have defined end dates, a price-anchoring method called a “funding rate” is established. It provides regular payments between buyers and sellers. The funding rate balances short and long positions by incentivizing a market balance. It’s like a rebate or fee to keep the market balanced.

The funding rate mechanism helps ensure the perpetual derivative contract price is close to the spot price. Exchanges use an oscillating price marker to determine if the longs or shorts need to pay fees or receive rebates. The funding rate is positive when the perpetual derivative price is above the spot price. In that scenario, longs pay a fee to the shorts.

Mark Price

The mark price is an estimate of the fair value price of a futures contract. It helps prevent unfair liquidations that can happen when the crypto market turns volatile. The mark price is often based on the index price and the funding rate. It is a key component of your unrealized profit and loss (PnL) calculation.

Insurance Fund

An insurance fund helps prevent balances from dropping below zero — and ensures that traders get any profits owed to them. If liquidations do not happen properly, the insurance fund backstops those losses until the positions are closed. Liquidation fees go into the insurance fund.

PnL

PnL can be unrealized or realized based on a trader’s open and closed positions. PnL is unique to the trader and unrelated to the mark price. Unrealized PnL is the driver of liquidations, so the mark price helps ensure that unrealized PnL numbers are accurate.

Auto-Deleveraging

Auto-deleveraging happens when an insurance fund stops working. Though it is unlikely, during certain market events profitable traders would be required to contribute part of their profits to cover other traders’ losses. Auto-deleveraging is a final measure when the insurance fund cannot cover all bankrupt accounts.

Perpetual Futures and Crypto

Perpetual futures are used to offer traders a market to hedge positions and manage risks without having to continuously put on new futures positions. You can also short crypto (such as Bitcoin) using perpetual futures. Finally, you can employ leverage in your crypto trading to amplify potential gains and losses with perpetual futures.

Crypto Derivatives

Crypto derivatives, including perpetual swaps and futures, allow traders to have exposure to cryptocurrencies without having to own digital assets outright.

The Takeaway

Perpetual futures and perpetual swaps are derivative instruments that allow traders to buy and sell crypto without having to constantly roll over expiring contracts. They can also be used as short-term trading vehicles for leveraged trading to go long or short.

Perpetual crypto futures and perpetual crypto swaps have become popular with cryptocurrency traders. After launching within the last several years, trading volume has risen substantially.

Knowing the ins and outs of futures and swaps can be intimidating for investors — particularly in an emerging trading world like crypto. If you’re interested in simply trading cryptocurrency, SoFi Invest® makes it easy, with more than two dozen cryptocurrencies to choose from, including Bitcoin, Chainlink, Ethereum, Dogecoin, Solana, Litecoin, Cardano, and Enjin Coin.

Find out how to get started with SoFi Invest.

FAQ

Can perpetual futures contracts expire?

No, perpetual futures contracts do not expire.

What are perpetual futures in crypto?

Perpetual futures in crypto are an unending type of advanced futures contract. The buyer and seller can hold the position for as long as they desire. With a perpetual futures contract, the buyer and seller go through a crypto exchange to form a transaction. The buyer is long (bullish) the underlying cryptocurrency while the seller is short (bearish).

How do perpetual futures work in a few words?

Perpetual futures work by allowing a buyer and seller to come together to speculate on cryptocurrencies or hedge existing positions. This type of crypto derivative enables traders to go long or short and use leverage.


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