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What is a perpetual futures contract?

What is a perpetual futures contract? Basic concepts to know

What is a perpetual futures contract? See now 04 basic concepts to know before trading Perpetual Futures Contracts here!!!

Perpetual Futures Contracts, or perpetual futures contracts, are one of the most used derivative products in crypto.

In today’s article, we will learn what a perpetual futures contract is, and some basic concepts to grasp before using it to avoid unnecessary losses.

What are Perpetual Futures Contracts?

Perpetual Futures Contracts are a type of futures contract with no expiration or settlement date that allows a trader to hold a position for as long as he wants.

In particular, a future contract (Future Contract) is an agreement to buy and sell between two parties on a transaction that will take place in the future, at a pre-determined price at the time of signing the contract.

Therefore, when you trade futures contracts in general or futures futures contracts in particular, it can be implied that you only trade the price of that commodity, and P/L (Profit/Loss – Ratio profit and loss) will be calculated using the specified underlying asset.

In Crypto, Perpetual Futures Contracts are one of the most traded derivatives by the vast majority of users because of their ease of use.

Top Derivatives Exchanges That Allow Forever Futures Trading

03 advantages of Perpetual Futures Contracts

Leverage

Perpetual Futures Contracts allow investors to trade positions larger than their account balance, it offers the opportunity to make many times more profit if the trader correctly predicts the trend price direction.

In Crypto, perpetual futures contracts support users to use maximum leverage from x20 – x100.

Binance allows 125X leverage

Risk reduction

In regular Spot Trading, the only way to make a profit is to buy low and sell high. But perpetual futures are more flexible, allowing traders to profit from long (buy low, sell high) or short (sell high, buy low).

Besides, traders can also use perpetual futures contracts for hedging in some cases.

For example, buy BNB spot join Binance Launchpad & Short BNB/USDT PERP to limit the risk of BNB price dropping sharply.

Flexible payment mechanism

On some professional Crypto exchanges, the trader’s P/L can be calculated in cash (USDC, USDT) or corresponding Crypto assets.

04 basic concepts to grasp

There are a few key concepts that traders need to grasp before trading Perpetual Futures Contracts to avoid unnecessary losses:

What is Initial Margin and Maintenance Margin?

Initial Margin is the minimum amount you have to pay to open a leveraged position, it acts as collateral.

Maintenance Margin is the minimum amount of margin you must maintain to keep trading positions open.

If your margin balance falls below this level, you will receive a request to add funds to your account, or accept the collateral to be liquidated. Maintenance Margin is a dynamic value that changes according to the market price and your account balance (collateral).

To put it succinctly:

  • Initial Margin is the minimum value you commit when opening a position.
  • Maintenance margin is the minimum balance you need to maintain to keep positions open.

The required maintenance margin is 4%

Liquidation

If the value of your collateral falls below the maintenance margin, your account may be liquidated. Depending on each Crypto exchange, the liquidation takes place in different ways.

Here is the logic process on FTX:

Asset liquidation process of FTX

But you should note one important thing, when being liquidated you will have to pay an additional liquidation fee, this number will be different in each floor.

To avoid that, you can:

  • Close your positions before reaching the liquidation price.
  • Add more money to your collateral balance, to make the liquidation price move further away from the current market price (folks call it pump armor).

Index Price & Funding rate

To avoid market manipulation, perpetual futures contracts create a new concept that is the underlying index price.

Index Price consists of the average price of an asset calculated based on the major spot markets and their relative trading volume.

Funding rate is the payout between all LONGs and SHORTs in the market. Funding rate determines which party is the payer and which party is the receiver:

  • If Funding rate is positive, LONG will pay to SHORT.
  • If Funding rate is negative, SHORT will pay LONG.

Index Price & Funding Rate when trading perpetual futures contracts with ETH

The combination of Index Price & Funding Rate will allow perpetual futures contracts to trade at or near the same price as the spot market.

Reference Price (Mark Price) & PnL

The reference price (Mark Price) is an estimate of the actual value of the contract (fair price) compared to its actual transaction price (Last Price on the Orderbook). The calculation of the reference price prevents unfair liquidation transactions when the market is volatile.

BTC reference price when trading perpetual futures contract

PnL stands for Profit and Loss, which means profit and loss.

  • When you have open positions on the Perp market, your PnL is unrealized (Unrealized PnL), which means it still changes with market moves.
  • When you close your positions, the unrealized PnL becomes the exercised (partially or fully) PnL. The reference price (Mark Price) is used to calculate the PnL.

PnL level when trading Perpetual Futures Contracts

Where to trade perpetual futures?

Almost all major Crypto exchanges currently offer Perp trading service because it is a derivative product favored by the vast majority of users.

Below are the popular and famous exchanges in the Crypto market. In which, the two leading exchanges currently are Binance and FTX (personal opinion).

Top derivatives exchanges that offer perpetual futures trading

Binance Exchange

Binance offers a wide range of crypto-related derivatives, especially in the Perpetual Futures Contracts segment, Binance also offers investors and traders 2 ways to participate in the market:

  • USDⓈ-Margined Futures Contracts: Supports perpetual futures contracts and is settled in USDT or BUSD.
  • Coin-Margined Futures Contracts: Supports crypto-settled perpetual futures contracts in Crypto.

Reference: Instructions for trading on Binance exchange

2 Ways to Trade Binance Futures

FTX Exchange

FTX exchange is one of the crypto exchanges offering the widest range of crypto-related derivatives on the market. As for Perpetual Futures Contracts, FTX only offers the type that is paid in USD.

The highlight of FTX is that they provide an easy way to create sub-accounts to limit the risk of positions. In addition, FTX also offers flexible collateral in various crypto-assets.

Reference: Instructions for trading on FTX

Trading perpetual futures on FTX

Summary

Perpetual Futures Contracts are one of the most used tools in crypto and they are suitable for a wide range of use cases due to their wide range of functions. However, investors need to have a clear understanding of their underlying mechanics before investing.

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