Perpetual futures contracts: What are they and how to trade them?

What are perpetual futures contracts?

Perpetual futures (or “perps” for short) are a type of derivative trading instrument. Perps make it possible to speculate on the prices of cryptocurrencies without actually owning the coins or tokens. As their name implies, perpetual futures do not have an expiry or final settlement date. Traders can keep their position open indefinitely, as long as they maintain a sufficient margin.

Unlike the trading of spot assets, perps make it possible to take a position on either side of the market—long or short. Perp traders can therefore take advantage of falling as well as rising prices in volatile markets.

What are perpetual swaps?

Perpetual swaps is another common name for perpetual futures. The term "swap" refers to the continuous nature of the instrument, where traders maintain their positions indefinitely by “swapping" payments based on the funding rate, without the need to close or roll over their contracts due to expiration.

Futures vs. futures CFDs vs. perp swaps

Futures, futures CFDs, and perpetual swaps are all derivative instruments that traders use to speculate on price movements. They have differences in their structure, the cost of keeping a position open, and the mechanics of how they are traded.

• Traditional futures contracts have a fixed expiration date (e.g., quarterly) and are settled either through physical delivery or in cash at expiration. Their standardised terms—fixed sizes and expiry dates—ensure reliability and ease of matching with real-world exposures for institutional traders, making them ideal for hedging.
• Futures CFDs have no fixed expiry date and can be held indefinitely. Of the three instruments in comparison, they offer the highest leverage but are subject to fees such as spreads, overnight financing charges, and currency conversion fees.
• Perpetual swaps stand out because they have no expiry date, allowing positions to be held indefinitely. However, they do involve trading fees. Additionally, a payment is made or received periodically through funding rates, typically every 8 hours. This funding mechanism helps keep the contract's price closely aligned with the underlying asset's spot price.

What is perpetual trading?

Perpetual trading refers to trading derivative futures contracts without an expiration date, primarily in the cryptocurrency markets, to profit from price movements, often with high leverage.

How do perpetual swaps work?

Perpetual swaps trading relies on mechanisms involving margin and leverage, liquidation, and funding rates.

Leverage, margin, and liquidation basics

• Leverage in trading involves using borrowed funds to control a larger position than one's initial capital allows. Think of it as using your money as collateral to borrow a larger sum. Axi offers up to 125:1 leverage for perpetual futures, which means that even small price movements could yield significant gains, but this also amplifies potential losses and heightens the risk of liquidation.
• Margin is the collateral a trader must deposit with a broker to both open (initial margin) and maintain (maintenance margin) a leveraged position, ensuring they can cover potential losses.
• Liquidation is the forced closure of a leveraged position when its value drops significantly, causing the margin ratio to fall below the maintenance level and triggering margin calls. Perpetual futures use a mark price (typically an index price) to calculate unrealised P&L and determine liquidation. Several factors can lead to liquidation, notably high leverage, sudden and large market swings, and a lack of proactive risk management.

What are funding rates?

Funding rates are a periodic payment mechanism used in perpetual futures designed to maintain the price of a contract closely aligned with the spot market. Since perpetuals have no expiry date, this approach ensures the contract price doesn’t drift too far from the asset’s index price. This peer-to-peer system involves either long or short positions, paying the opposing side depending on market conditions.

A positive funding rate means traders holding long positions pay shorts, typically due to buying pressure pushing the futures price above the spot price. Conversely, a negative funding rate means short positions pay longs, usually when the futures price falls below the spot price due to selling pressure.

Funding is usually charged every eight hours, and its calculation considers factors like the interest rate differential and the price spread between the perpetual contract and the underlying asset.

For example, consider a situation where Bitcoin's spot price is $80,000, but the perpetual futures price has increased to $82,000 because many traders are opening long positions. In this case, a positive funding rate is applied. This rate creates a financial incentive where long position holders are charged a fee, and short position holders receive that fee. This motivates longs to potentially close their positions (to avoid the cost) and encourages shorts to open or maintain positions (to earn the payment). This shift in trading activity helps to gradually push the perpetual futures price back down, bringing it closer in line with the spot price.

Beyond price alignment, funding rates have practical implications for traders. They directly impact trading costs and can affect profitability, especially for positions held over extended periods. During volatile market phases, high funding rates can erode profits or amplify losses. Furthermore, funding rates can introduce strategic considerations, where traders may benefit from holding positions that receive payments during sustained imbalances.

What are Maker and Taker fees in perpetual futures trading?

Platforms that offer trading on perpetual futures typically use a maker-taker fee model for transaction fees. When placing an order, traders are classified as either a maker or a taker, which determines the fees they pay.

Maker fees are charged for limit orders that are not instantly matched. These fees are usually lower, rewarding the trader for adding liquidity to the order book. This makes them ideal for swing traders or those who can be patient with their entries and exits.

Taker fees, on the other hand, are charged on orders that are executed immediately, such as in the case of ‘market’ orders. Taker fees are generally higher, as the trader is, in this case, "taking" liquidity from the order book. This is the trade-off for fast fills, especially during volatile market conditions.

Most popular perp trading strategies

Perpetual futures' key attributes, such as leverage and no expiration date, make them versatile for many trading strategies. However, certain strategies uniquely leverage their structure and demonstrate their advantages.

Using perpetual futures for hedging spot positions

To guard against price drops, traders can use perpetual futures for hedging instead of selling their crypto assets.

Selling spot assets to avoid short-term volatility carries risks. A quick price rebound could mean missing out on gains, and selling can also trigger taxable events or cause traders to lose benefits associated with holding the asset, such as staking rewards.

To navigate temporary price fluctuations without selling their long-term cryptocurrency investments, traders often require specific risk management strategies. Hedging with perpetual futures offers a solution by allowing traders to reduce or neutralise their exposure to downside price movements while still maintaining their underlying spot positions.

A hedge in this context involves taking an offsetting position in the perpetual futures market that is opposite to the spot position. For example, imagine you hold 1 BTC in your spot wallet, representing a long position. If you anticipate short-term price volatility and are concerned about a potential drop but do not wish to sell your BTC, you can open a short position of the same size (1 BTC) in BTC perpetual futures.

If the price of BTC subsequently drops, the loss in value of your spot position will be offset by the gains from your short perpetual futures position. This strategy effectively allows you to temporarily lock in the USD value of your BTC holding, acting as a form of insurance. This can be achieved without the need to sell your actual BTC, thereby avoiding potential tax implications or losing custody benefits like staking rewards.

Funding Arbitrage

Another strategy traders use is cash-and-carry arbitrage, which involves taking advantage of funding rate differences between perpetual futures and spot markets; the idea is to profit from these payments while avoiding the associated risk. For example, if the funding rate is positive (meaning longs pay shorts), a trader can simultaneously short the perp and buy the equivalent amount of the underlying asset in the spot market, allowing them to collect the funding payment.

If the funding turns negative (meaning shorts pay longs), the inverse applies. The trader can go long on the perp and hedge it by selling the equivalent of a spot asset. For example, if the ETH perpetual funding rate is +0.03% every 8 hours (equating to 0.09% daily), shorting the perpetual and holding an equivalent spot ETH position could potentially generate a yield of 0.09% daily on the notional value, offering a relatively low-risk return.

Pros and cons of perpetual swap contracts

Pros

Perpetual swap contracts offer several advantages. These include round-the-clock trading, as crypto markets are open 24/7, and leverage, which significantly improves capital efficiency, creating more trading opportunities. They also allow traders to profit from both rising and falling markets by taking long or short positions.

Furthermore, dynamic funding rates present opportunities to earn passive income, while deep liquidity ensures lower slippage and tighter spreads during trading. Perpetual futures trading also benefits from transparent fee structures and clear order execution, often facilitated by a visible order book.

Cons

Conversely, perpetual instruments present several risks. The combination of high leverage and market volatility creates a significant liquidation risk that can amplify losses. Furthermore, their complexity may pose difficulties for new traders, and funding fees can potentially diminish profits over longer holding periods.

How to trade perpetual contracts with Axi

Here’s a quick walkthrough on how to trade perpetual futures on the Axi Trading Platform:

1. Fund your account using a method available in your region, such as bank transfer, credit/debit card, e-wallet, or crypto.
2. Access the crypto dashboard and select "Cryptos" or browse “Popular Markets”.
3. Select an instrument: Browse available contracts (e.g., BTC/USD Perp) and tap to open the order ticket.
4. Place your order: Enter units, select leverage, choose Buy or Sell, and confirm the order.
5. Monitor and manage your position: Real-time P/L tracking is available on the dashboard. Adjust Take Profit, Stop Loss, or close positions manually as needed.

Summary

Perpetual futures excel in crypto trading due to their flexibility and leverage potential. They're particularly effective for short-term intraday trading, enabling traders to amplify profits from small price movements with minimal funding fees and no overnight swap charges. Perps also eliminate the rollover hassle associated with traditional futures, which is ideal for swing traders maintaining positions over several days or weeks. Highly liquid markets like BTC/USDT and ETH/USDT ensure tight spreads, fast execution, and reduced slippage.

Finally, perpetual contracts simplify short selling, making them valuable tools for managing risk and capitalising on market volatility. While margin is required to hold a position and funding fees apply periodically, this mechanism is typically more accessible than traditional methods involving asset borrowing.

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This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation and needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability with regard to the accuracy and completeness of the content in this publication. Readers should seek their own advice.