Perpetual Contracts vs. Traditional Futures Contracts: Understanding the Key Differences
In the world of derivatives trading, there are two main types of contracts: perpetual contracts and traditional futures contracts. While both of these instruments help to speculate on the future price movements of an underlying asset, there are some distinct differences between the two.
In this article, we will take a closer look at perpetual contracts and traditional futures contracts and compare them in terms of their features, advantages, and disadvantages.
What are perpetual contracts?
Perpetual contracts are a relatively new type of derivative contract introduced in 2016.
They are an attempt to take advantage of a futures contract. Perpetual contracts are essentially a form of a futures contract with no expiration date. ThisIt means that traders can hold a position in a perpetual contract for as long as they want, without worrying about the contract expiring.
How do perpetual contracts work?
Perpetual contracts use a funding mechanism to ensure that the price of the contract stays in line with the underlying asset. The funding rate is calculated periodically and based on the difference between the price of the contract and the price of the underlying asset.
If the price of the contract is trading at a premium to the underlying asset, then long positions in the contract will have to pay a funding rate to short positions. Conversely, if the price of the contract is trading at a discount to the underlying asset, then short positions in the contract will have to pay a funding rate to long positions.
What are traditional futures contracts?
Traditional futures contracts, on the other hand, have a fixed expiration date. Futures contracts are used to hedge against price risk and to speculate on the price movements of an underlying asset.
One of the key features of traditional futures contracts is that they are settled daily. As a result, any profits or losses realised on a futures contract are settled daily, rather than being settled at the expiration of the contract.
What are the differences between perpetual and traditional futures contracts?
There are several differences between perpetual contracts and traditional futures contracts.
One of the biggest differences is the fact that perpetual contracts have no expiration date, whereas traditional futures contracts do. With this, traders who use perpetual contracts have more flexibility on how long they can hold their positions.
The funding mechanism is another important element in perpetual contracts. The funding mechanism ensures that the price of the contract stays in line with the underlying asset, which can help reduce the risk of price manipulation.
Traditional futures contracts, on the other hand, are settled daily, which means that any profits or losses realised on a futures contract are settled daily. Although, this can be both an advantage and a disadvantage, depending on the trading strategy used.
What are the key concepts that traders should be aware of in a Perpetual Contract?
Here are some key concepts that traders should be aware of in a perpetual contract:
- Funding rate: Perpetual contracts employ a funding rate mechanism to keep the contract’s price aligned with the underlying asset’s price. This mechanism involves the exchange transferring funds between traders to ensure that the perpetual contract’s price stays close to the spot price of the underlying asset. If the perpetual contract is trading above the underlying asset’s price, traders holding long positions will pay a funding fee to traders holding short positions, and vice versa.
- Leverage: Traders can use leverage to amplify their potential profits and losses when trading perpetual contracts. It allows traders to control a larger position with a smaller amount of capital. However, it’s important to note that trading with leverage increases the risk of liquidation.
- Margin: Traders must maintain a margin account when trading perpetual contracts. This margin is used to cover any potential losses that may occur due to adverse price movements. If the trader’s margin falls below the required maintenance margin, the trader may be subject to liquidation.
- Settlement: Perpetual contracts do not have a fixed expiration date, and the contract is settled continuously. The settlement occurs when a trader closes their position; or the position is liquidated, due to insufficient margin.
- Mark Price: Perpetual contracts utilise mark price to calculate profits and losses, which is the average of the last traded price on multiple exchanges. It helps to prevent manipulation of the contract’s price and ensures that the contract price is in line with the underlying asset’s price.
What are the advantages and disadvantages of perpetual and futures contracts?
Perpetual contracts offer several advantages over traditional futures contracts. For example, they give more flexibility on how long traders can hold their positions.
They also use a funding mechanism that can help to reduce the risk of price manipulation.
Perpetual contracts have become increasingly popular among traders in the crypto market due to their flexibility and the ability to trade with leverage.
However, perpetual contracts also have some disadvantages. For example, they can be more complex than traditional futures contracts, which may make them more difficult to understand for some traders. They also tend to have higher trading fees than traditional futures contracts.
Where do I trade perpetual futures contracts?
If you’re interested in trading perpetual futures contracts, LBank is a platform worth considering. With LBank’s mobile app, you can download and trade crypto perpetual contracts with leverage ranging from 20–25x.
Additionally, you have the option to use Tether (USDT), a stablecoin, to adjust leverage and margins after opening long or short positions.
It is important to bear in mind that the maximum leverage allowed on LBank depends on the notional value of your position. Generally, the larger the position, the lower the leverage allowed. Therefore, initial margin deposits are calculated based on the leverage selected by the trader.
As with any form of trading, it’s essential to be well-informed and understand the risks involved before engaging in any trading activity. It’s also important to only invest what you can afford to lose and to consider your own risk tolerance.
Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.