In this article, you will learn what are perpetual futures and three risks to perpetual futures contracts. In finance, a perpetual futures contract, also known as a perpetual swap, is an agreement to non-optionally buy or sell an asset at an unspecified point in the future. Perpetual futures are cash-settled, and differ from regular futures in that they lack a pre-specified delivery date, and can thus be held indefinitely without the need to roll over contracts as they approach expiration.
Traders are making massive gains from perpetual futures contracts but there are three risks to be aware of before trading.
What is a futures contract?
A futures contract is an agreement to buy or sell a commodity, currency, or another instrument at a predetermined price at a specified time in the future.
Unlike a traditional spot market, in a futures market, the trades are not 'settled' instantly. Instead, two partners will trade a contract that defines the settlement at a future date. Also, a futures market doesn't allow users to directly purchase or sell the commodity or digital asset. Instead, they are trading a contract representation of those, and the actual trading of assets (or cash) will happen in the future - when the contract is exercised.
What are perpetual futures?
A perpetual contract is a special type of futures contract, but unlike the traditional form of futures, it doesn't have an expiry date. So one can hold a position for as long as they like. Other than that, the trading of perpetual contracts is based on an underlying Index Price. The Index Price consists of the average price of an asset, according to major spot markets and their relative trading volume.
Thus, unlike conventional futures, perpetual contracts are often traded at a price that is equal or very similar to spot markets. However, during extreme market conditions, the mark price may deviate from the spot market price. Still, the biggest difference between the tradition futures and perpetual contracts is the 'settlement date' of the former.
- Leverage leads to stronger wicks
Regardless of how liquid a market is, leverage will result in stronger wicks. Even though these moves usually don't lead to forced liquidation, it might run investors' stops.
Therefore, the possibility of errant wicks are the main reason traders should avoid carrying futures positions for more extended periods.
Futures liquidation engines use a price index composed of multiple spot (regular) exchanges to avoid price manipulation. Thus, the system will only close positions with insufficient margin once an index reaches its stops.
- Staking and liquidity mining may offer a better yield
Buying altcoins using futures does not allow one to use them for staking or lending. For investors willing to carry a position for a longer-term, this is another factor to consider.
Decentralized (DeFi) mining pools are another way to generate income by holding altcoins. Users should beware of this sector's inherent risks, especially those pools with impairment loss occurring between two different cryptocurrencies.
Thus, by opting for perpetual futures, one will not be able to partake in staking and yield farming. It might not impact the decision for those betting on short-term price swings, but it weighs more as the weeks go by.
- Beware of fluctuating funding rates
Perpetual contracts, also known as inverse swaps, have an embedded rate that usually charged every eight hours. Funding rates ensure there are no exchange risk imbalances. Even though both buyers and sellers open interest is matched at all times, leverage can vary
When buyers (longs) are the ones demanding more leverage, the funding rate goes positive. Therefore, those buyers will be the ones paying up the fees. This issue holds especially true under bull run periods, when usually there's more demand for longs.
Bottom Line
Before opening any trade at an exchange offering perpetual futures, traders should be aware that stronger wicks can run stop losses, investors lose the ability to stake their altcoins for lucrative yields, and the variable funding rate can significantly increase the costs of trade decarrying. So, you should know what are perpetual futures and three risks to perpetual futures contracts.
