Weekly Market Update - Friday, May 19, 2023

Perpetual Futures Contracts in Crypto

Many of the financial derivative products present in traditional financial markets have made their way over to the crypto ecosystem, offering crypto traders the ability to develop more sophisticated trading strategies. Today, we provide a high-level overview of one type of derivative, perpetual futures contracts or perps.

What are perps?

Before diving into the specific characteristics of perps, we must first understand futures contracts, or futures. A future is a derivative instrument whose value is tied to another underlying asset. In crypto, the underlying asset is a token like BTC. As the value of BTC goes up, so does the value of the BTC future. If you buy a BTC future, you profit when BTC goes up. Similarly, if you short sell a BTC future, you profit when BTC goes down.

Learn more about crypto derivatives here.

There are two types of futures: dated and perpetual (perp). The major difference is that dated futures have an expiration date. When an expiration date is reached, trader profits and losses are realized and settled. Perps, on the other hand, never expire and therefore profits and losses are only realized after the position is closed.

Why trade a perp rather than the asset itself?

If the value of a perp is tied to the value of the underlying asset, why not just trade the asset? There are several reasons traders decide to trade perps, which mostly have to do with characteristics of perps that generally do not exist with spot.

• Shorting — In the spot market, the choices a trader has are generally to hold an asset or not hold an asset. There isn’t a readily available mechanism to directly bet against a crypto asset. With perps, you can take a short position, effectively betting against an asset to profit when the price falls.
• Leverage — With spot, if the price of the asset goes up 10%, the value of the position also goes up 10%. When trading perps, a trader can use leverage, which has a multiplier effect on gains and losses, sometimes as high as 100x or 125x. Leverage enables traders to take larger positions without investing more capital. This is often known as trading on margin.
• Never holding the asset — Most crypto perps contracts are denominated and settled in a stablecoin, meaning you never have to hold the underlying asset in your margin account to trade the corresponding perp. This is especially beneficial if you trade several different perps (BTC, ETH, SOL, etc.) because you only need to hold one stablecoin in your margin account, rather than each crypto.

How are perps typically used?

There are multiple reasons to trade perps, we’ll touch on a few of them here:

• Speculation — the most obvious use of perps is to make a directional bet on the price of an asset. For the benefits stated above, perps can allow an investor to efficiently manage the direction and size their position.
• Hedging — if a trader is holding an asset but wants to be insulated from the risk of the asset going down (hedged), they can offset their holding by taking a short position in the perp without having to sell the asset outright.
• Trading strategies — The flexibility and structure of perps makes them ideal for a variety of trading strategies. One example is basis trading, where a trader effectively arbitrages price differences between spot, perps, dated futures or even similar instruments on different exchanges.

See you next week. Onward and Upward!

Team Gemini

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