Anything can be longed or shorted.
In order to do so, you need specific financial tools such as perpetual futures / perpetual swap contracts, short: perps.
In this guide we'll look at what perpetual futures / perpetual swap contracts are, why they make sense and how you can benefit from them.
What Are Perpetual Futures?
Both futures contracts and perpetual futures are derivatives.
This means that they derive their value from an underlying asset or index.
Put differently: A derivative mimics the value, i.e. index/spot price, of a predefined asset.
Generally, derivatives were created out of the necessity to offset and trade risks.
As such, they provide three main purposes:
- Insuring against uncertain price movements (hedging)
- Increasing exposure to particular markets (leverage)
- Making hard to trade assets more accessible (e.g. commodities and trading indexes)
Futures contracts allow you to purchase or sell an asset or index at a specific price on a specific date.
Basically, futures contracts are the predecessors of perpetual contracts i.e. perpetual futures.
Introduced in 2016, perpetual futures are futures contracts that are not activated / do not expire on a specific date or price, hence the name perpetual.
This means you can hold and maintain your perpetual futures positions as long as you want to and as long as you have the collateral to back it up.
Perpetual futures are now the most liquid derivative instrument in decentralised finance (DeFi), making up more volume than spot markets.
Read our Decentralised Finance (DeFi) guide if you want to learn more.
Why Use Perpetual Futures?
Let’s take a look at some examples:
- Longing & Shorting (Directionality)
Perpetual futures allow you to speculate whether the price of an asset will go up or down.
If you believe that the price of an asset will drop, you can short it using perpetual futures contracts — and when you believe that the price of an asset will increase, you can long it using perpetual futures.
Say the current price of Solana (SOL) is at $100 and you believe it's overvalued.
You can take a short position using SOL-PERP to bet against the price of SOL.
If the price of SOL decreases to say $80, you’ve successfully shorted SOL and will receive the corresponding profits.
The same logic applies when longing an asset.
Say you bought SOL at $55 and it appreciates to $80.
You believe Solana’s fair value to be $120 though, so you don’t want to sell just yet.
At the same time you’re also expecting a short-term pullback in price.
In this case, you can take a short position using SOL-PERP to hedge against the spot SOL you bought.
When the pullback is complete and the SOL price rises again, you receive the corresponding profits of your short position without having to sell your spot SOL.
This puts you in an even more comfortable position while waiting for your SOL sale target of $120.
- Leverage & Margin
Finally, perpetual futures also give you access to leverage, a powerful and dangerous tool.
Say you have $1,000 at your disposal and you have a high conviction that the price of SOL will increase in the near future.
Leverage allows you to maximise your exposure to SOL in a straightforward manner.
By using this technique, you can maximise your exposure to SOL by leveraging your balance of $1,000 as collateral.
This allows you to enter a position multiple times larger than your initial balance.
Say you want to long SOL with leverage using SOL-PERP.
You can do so by purchasing e.g. a 20x leverage on your $1,000 collateral — meaning you’d acquire $20,000 worth of SOL-PERP.
If the SOL price rises, your potential upside increases by 20x.
Despite this, leveraging is highly risky.
If the price of SOL-PERP decreases by just 5%, you will be liquidated and will lose your entire $1,000 collateral.
Always bear the risks in mind when using leverage!
Funding Rates For Perpetual Futures
Perpetual futures themselves are valueless — at the end of the day they are just contracts.
As mentioned earlier, perpetual futures are derivatives that mimic the value i.e. index/spot price of predefined assets.
How do they have value and remain tethered to the price of their underlying asset though?
When the prices of perpetual futures deviate from the index/spot price of their corresponding assets, funding rates are paid out by centralised exchanges (Binance, Coinbase or Kraken) and decentralised exchanges (Drift) as periodic payments (typically hourly).
These funding rates motivate traders to open either short or long positions to help bring the prices of perpetual futures back i.e. closer to the spot prices of their corresponding assets.
It’s referred to as a price premium when the perpetual futures price is higher than the spot price of the corresponding asset (positive funding rate), and as a price discount when the perpetual futures price is lower than the spot price of the corresponding asset (negative funding rate).
When the funding rate is positive, traders can bring the perpetual futures price back i.e. closer to the spot price by opening more short positions.
This means that long positions pay the funding rate to short positions.
When the funding rate is negative, traders can bring the perpetual futures price back i.e. closer to the spot price by opening more long positions.
This means that short positions pay the funding rate to long positions.
A common misconception is that a positive funding rate indicates that there are more longs than shorts, and a negative funding rate signals that there are more shorts than longs.
This is NOT the case.
Simply put: Funding rates DON’T determine whether there are more longs or shorts.
They rather examine the mark price of perpetual futures contracts and the oracle they are tethered to.
We hope our guide helped you in understanding what perpetual futures / perpetual swap contracts are, why they make sense and how you can benefit from them.
Remember, using trading perpetual futures / perpetual swap contracts can be risky!
Disclaimer: This guide is strictly for educational purposes only and doesn’t constitute financial or legal advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.
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