What is a perpetual contract in crypto?

Understanding Perpetual Contracts in Cryptocurrency

A perpetual contract is a type of derivative financial instrument commonly used in cryptocurrency trading. Unlike traditional futures contracts that have a set expiration date, perpetual contracts do not expire. This allows traders to hold their positions indefinitely, provided they meet the margin requirements and pay or receive funding fees. These contracts are typically settled in cryptocurrency, often USDT or BTC, and mirror the price of an underlying asset such as Bitcoin (BTC) or Ethereum (ETH).

The core appeal of perpetual contracts lies in their flexibility. Traders can take long positions (betting the price will rise) or short positions (betting the price will fall) without worrying about contract expiry. This makes them ideal for both short-term speculation and longer-term strategic positions. The mechanism that keeps the contract price close to the spot price is known as the funding rate, which will be explained in detail in a later section.

How Perpetual Contracts Differ from Traditional Futures

Traditional futures contracts are agreements to buy or sell an asset at a predetermined price on a specific future date. Once that date arrives, the contract settles, and the position closes. In contrast, perpetual contracts have no settlement date. This fundamental difference allows traders to maintain open positions for as long as they desire.

Another key distinction is the funding mechanism. Because perpetual contracts don’t expire, there needs to be a way to align the contract price with the spot market price. This is achieved through periodic funding payments exchanged between long and short holders. If the perpetual contract trades above the spot price, longs pay shorts; if it trades below, shorts pay longs. This incentivizes price convergence.

Furthermore, perpetual contracts are often leveraged, meaning traders can control large positions with relatively small amounts of capital. Leverage levels vary by platform and can go as high as 100x or more, significantly increasing both potential gains and risks.

Role of the Funding Rate in Perpetual Contracts

The funding rate is a critical component of perpetual contracts. It ensures that the contract price does not deviate significantly from the underlying asset’s spot price. Funding rates are typically exchanged every 8 hours on major exchanges like Binance, Bybit, and OKX.

The funding rate is calculated based on two components: the interest rate offset and the premium index. Most platforms assume a zero interest rate for crypto, so the premium index becomes the dominant factor. This index reflects the difference between the perpetual contract price and the spot price, adjusted for basis.

• If the funding rate is positive, long position holders pay short position holders.
• If the funding rate is negative, short position holders pay long position holders.

Traders must monitor funding rates closely, especially when holding positions over extended periods. High positive funding rates can erode profits for long holders, while high negative rates can increase costs for short holders. Some traders even engage in funding rate arbitrage, opening opposite positions on spot and perpetual markets to capture funding payments.

How to Trade Perpetual Contracts: A Step-by-Step Guide

Trading perpetual contracts involves several precise steps. Below is a detailed walkthrough using a typical exchange like Bybit:

• Create and verify an account on a reputable crypto derivatives exchange. Complete KYC if required.
• Deposit funds into your futures wallet. This can be done using stablecoins like USDT or native coins like BTC.
• Navigate to the perpetual contracts section and select the trading pair you want, such as BTC/USDT.
• Choose your leverage using the leverage slider. For example, selecting 10x means you control 10 times your margin.
• Decide between a long or short position based on your market outlook.
• Select your order type: use a limit order to set a specific entry price or a market order to enter immediately.
• Set stop-loss and take-profit levels to manage risk and lock in profits automatically.
• Confirm the trade and monitor your position in the open orders tab.

It’s essential to understand liquidation price, which is the price at which your position will be automatically closed due to insufficient margin. You can adjust your leverage or add margin to move the liquidation price further from the current market price.

Risks and Margin Management in Perpetual Trading

Perpetual contracts involve significant risks due to high leverage and volatility. One of the primary risks is liquidation, where the exchange closes your position if your margin falls below the maintenance threshold. To avoid this, traders use isolated margin or cross margin modes.

• Isolated margin assigns a fixed amount of margin to a single position. Losses are limited to that amount, but liquidation occurs if the price hits the threshold.
• Cross margin uses the entire wallet balance to support the position, reducing the chance of liquidation but exposing more funds to risk.

Additionally, market volatility can trigger rapid price movements, especially during news events or macroeconomic shifts. Sudden spikes or drops can lead to slippage and unexpected liquidations. Using stop-loss orders and avoiding excessive leverage are key risk mitigation strategies.

Funding fees also accumulate over time and can impact profitability. Holding a long position during a period of consistently high funding rates may result in substantial ongoing costs.

Frequently Asked Questions

What happens if I don’t close my perpetual contract position?You are not required to close your position. As long as you maintain sufficient margin and pay funding fees (if applicable), your position remains open indefinitely. The exchange will only close it if your equity falls below the maintenance margin, leading to liquidation.

Can I trade perpetual contracts with USDC?Yes, several exchanges like dYdX and Bitget support USDC-settled perpetual contracts. These operate similarly to USDT-settled ones but use USDC as the base or quote currency. Ensure the trading pair you select explicitly supports USDC.

How often is the funding rate applied?Funding payments are typically exchanged every 8 hours at predetermined times, such as 00:00 UTC, 08:00 UTC, and 16:00 UTC. The exact schedule depends on the exchange. You only pay or receive funding if you hold a position at the time of the funding interval.

Is trading perpetual contracts legal everywhere?No. Regulatory treatment varies by jurisdiction. Countries like the United States restrict access to crypto derivatives for retail investors on most platforms. Always verify the legal status of perpetual trading in your country before engaging. Exchanges often enforce geoblocking to comply with local laws.