As the cryptocurrency market is getting diversified, trading on the centralized exchanges now includes several order types. Perpetual contract is one of them. In principle, these are a variation of futures contracts without an expiry date.
When a trader opens a perpetual swap trade, they have to pay a funding fee. The exchange assures that the perpetual price meets the actual cost of the trade by exchanging users’ currency swaps.
If the perpetual price goes higher than the spot market price, long users pay a funding fee to short users and vice versa. If you want to venture into this trading domain, you may have specific questions that need answers. Here, they are:
What are the Main Characteristics of a Perpetual Swap Contract?
In perpetual contracts, you don’t have to hold an underlying asset to buy or sell on future prices. You can buy the contract if you expect the prices to rally or sell if you are anticipating a price fall. There is no specific termination date in this order type. Though, they have some similarities to futures contracts and spot trading as well.
The main characteristics of perpetual swaps include the possibility of leverage trading up to 100x as well. Usually, the leverage is high, and traders can create a position with a fraction of their balance. As a result, the contracts offer better potential to earn high returns even from a small initial outlay. Some exchanges may also provide safe liquidation to keep your contracts secure and transparent.
What is the Funding Rate in Perpetual Swaps?
Funding refers to regular payments taking place between sellers and buyers based on the current rate. It is the primary mechanism that relates prices of a perpetual contract to spot trading. Funding may involve a series of consecutive payments between long and short users.
The calculation of the funding rate is based on the premium and interest rates. In most of the markets, interest rates are fixed, but the premium may vary due to the price difference between spot and futures contracts. Funding will keep the prices of perpetual contracts close to the spot trading prices. Here’s how:
- When a perpetual swap price is higher than the spot price, funding is favorable, and longs will pay to the shorts. It gives an incentive to stay short or get into a new short position for earning profits. As a result, perpetual swap prices will fall toward the spot prices.
- When you trade perpetual contracts at a discount or a price lower than spot, the funding will be negative, and shorts will pay to longs. As a result, there will be incentive to stay long or create a new long position. The prices of a perpetual swap contract will move up in this condition.
So, the funding rate is an 8-hourly interest that’s computed every minute. Exchanges may cap the magnitude of funding rate from one contract to another.
Is It Safe to Deal With Perpetual Swaps?
In the cryptocurrency derivatives trading, the security of crypto exchanges is essential for the trade’s success. It helps to increase the confidence of the traders in the markets. Blockchains are not at the base of this problem because it is not viable to reverse blockchain transactions during the majority attack. That’s because it requires computing technology and protective measures taken by the creator.
Usually, the hacks are planned by the third parties. The hot wallets at the exchanges, however, are vulnerable to phishing attacks. If hackers attack, they can steal not only the funds but also the traders’ critical personal information. Hence, you can’t ignore the significance of security when trading in a perpetual contract.
If the exchange guarantees security, the derivative products will be highly successful. Lay your trust in an exchange that ensures mandatory AML procedures, regular third-party testing, using demilitarized zones for routing external communications, and wallet protection.
Are Perpetual Swap Contracts Legal?
Many countries haven’t yet regularized cryptocurrency trading. But, perpetual swap contracts are legal in jurisdictions that allow this trading. Usually, the exchange has to provide an ideal environment for trade in these order types because they don’t have a specific expiry.
Many new trading platforms are offering diverse ways to apply leverage in orders to gain through perpetual swaps. They have a significant advantage over the futures market, where traders can hedge and hold their trades for more extended periods. Also, there are no additional costs besides the funding rates. If you want to enter this market, use reliable exchange services to make the most of it.
Smriti Jain is the owner and senior content publisher at Financesmarti. Financesmarti is a website where she shares a lot of useful stuff for the people and business of India. This includes small business ideas and other banking information, as well. Smriti completed her education in science & technology from Delhi University. Smriti usually has interests in digital marketing now, and she has chosen this career for the full-time opportunity. The primary purpose of starting this blog to provide quality information on the banking industry to the people.