Perpetual swaps have exploded in popularity along with the rise of cryptocurrency. As crypto-derivatives contracts, they’re closely tied to the surge in trading Bitcoin, Ethereum and other tokens. They’re usually traded on large derivatives exchanges, such as BitMEX and OKEx, but are increasingly being offered by spot exchanges too.
In this guide to perpetual swaps, we’ve explained what they are and how they work, along with an example. We’ve also listed the steps to get started trading perpetual swaps.
What Is A Perpetual Swap?
Perpetual swaps are a type of derivative contract, meaning their value is tied to that of an underlying asset. They are essentially futures contracts, but the key difference is that they don’t have an expiry date. In this way, they are perpetual – they never end – as the name suggests.
They are designed specifically for cryptocurrencies, such as Bitcoin, and have not reached other asset classes yet. This is because a perpetual swap contract is a peer-to-peer instrument, as opposed to a CFD with a broker, for example.
How Perpetual Swaps Work
Perpetual swap contracts mirror the asset’s value through a ‘funding rate mechanism’.
This is a fee or rebate for the purchaser and is used to balance supply and demand. When the price of the perpetual swap is higher than that of the underlying asset, the funding rate is positive. This means traders who are long pay a fee to those opening short positions. It encourages arbitrage traders to swoop in and purchase short positions, which brings the price down in line with the asset’s true value.
Conversely, if the funding rate is negative, it means the perpetual swap is trading at a price that is lower than the market rate. A negative funding rate means shorts are paying for longs, encouraging long positions and raising the price. Most exchanges provide a list of predicted funding rates for perpetual swaps to help you plan your strategy.
Inverse Perpetual Swaps
There are also inverse perpetual swap contracts that use a cryptocurrency (such as BTC, ETH or LTC) as the base currency, but fiat currencies as the quote currency. In any forex currency pair, such as GBP/USD, the first three letters represent the base currency, meaning that is the asset held by the trader. The last three letters are known as the quote currency, i.e the currency you’ll receive. Inverse swaps are the opposite, making it easier for some traders to understand because the value is quoted in USD rather than crypto. Most traders will appreciate the value of 10 USD, but may not know that it equates to 0.0004 BTC, for example. So, a BTC/USD inverse perpetual swap means you are buying 1 USD of Bitcoin at the Bitcoin price quoted.
Perpetual Swaps Vs CFDs
Perpetual swaps are similar to CFDs in that they are both derivative contracts that allow traders to utilise leverage as well as open short positions.
However, there are some key differences:
- Assets – CFDs are available on a wide range of assets, including forex, stocks, indices, commodities and cryptos. Perpetual swaps are primarily available on cryptocurrencies.
- Contractees – A CFD contract is typically held with a broker, whereas a perpetual swap is a peer-to-peer contract. Perpetual swaps are primarily traded on decentralised exchanges, rather than through brokers.
- Pricing – With a CFD, brokers make a profit through fees. These are usually spreads, i.e the difference in ask and bid price that means a broker can profit from each trade. There may also be rollover fees for holding CFDs overnight and a fixed commission charge. With perpetual swaps, the main charge is simply the funding rate. This is not a fee that is paid to an exchange, but one that is transferred peer-to-peer with the aim of keeping the swap value in line with the market. Additionally, there may be some small fees that go to the exchange, but these are usually less than 0.05% of the contract value.
Perpetual Swaps Vs Futures
Put simply, perpetual swaps are futures contracts with no expiry dates. They enable traders to open leveraged positions without having to monitor the settlement dates of contracts. In this way, perpetual swaps are very similar to trading spot crypto, but with the added benefits of leverage and the ability to open short positions.
Pros Of Perpetual Swaps
- Leverage – Traders can use leverage to open positions much larger than their deposit amount.
Leverage essentially allows traders to multiply the results of a trade. This can lead to increased profits for successful investors.
- Hedging – Perpetual swaps allow traders to open short positions as well as going long. This is ideal for hedging spot trades and profiting even when a market is in decline.
- DeFi – DeFi (or Decentralised Finance) is the concept of operating financial services without a central organisation. Where most financial services are provided by banks, asset managers, insurers and brokers, DeFi offers increased control and flexibility to individuals looking to generate profits from their own funds.
- Simple – Since there are no expiry dates, perpetual swaps are arguably straightforward for traders to manage. There is no monitoring of settlement dates because perpetual swaps will continually roll over.
Cons Of Perpetual Swaps
- Risky – Leveraged trading means increased risk exposure. While this can result in huge rewards, it means losses can rack up too. Since crypto derivatives are a fairly new asset, many of the world’s regulators are yet to legislate on them. With that said, the UK’s FCA has taken a severe stance, banning all crypto derivatives for British traders, citing the volatility of the cryptocurrency markets and the risks posed by leveraged trading positions.
- Funding Rate – The funding rate is a continual charge or rebate depending on the direction of your position.
So, if you’re holding a long position when the funding rate turns positive, you’ll end up paying to keep the position open. This is true even if the funding rate was negative when you opened the position.
How To Start Trading Perpetual Swaps
Select An Exchange
Many of the top crypto derivative exchanges do not facilitate the purchase of spot crypto. Therefore, you’ll need to buy your tokens elsewhere and load them into your wallet. Alternatively, select an exchange that allows both, such as Kraken or Binance.
Open An Account
Open an account and complete the KYC checks.
Move Tokens Into Your Perpetual Swaps Account
Load your crypto into your perpetual swaps account. The location varies by broker. On OKEx, for example, this is available from the drop-down menu, under Trade.
Implement A Strategy
It’s vital that traders do not enter a trade without a strategy. For years, a forex trader’s mantra has been ‘plan the trade, trade the trade’ and crypto investors should be no different.
Decide where you’ll close your position before you open the order and stick to it.
Choose Your Perpetual Swap Details
Select the asset and leverage required and then enter your order size. As part of your risk management strategy, you’ll want to implement a stop loss. This will automatically close your trade if the price drops below your set limit. With a perpetual swap contract, there are two prices to be aware of: the mark price and the last price. The last price is the actual trading price of the contact and the mark price is an estimate of its true value. Consider whether you want to set your stop loss towards the mark price or last price. Some traders prefer to tie it to the mark price which will prevent rogue stops when the market is particularly volatile.
Review your trade details and click the relevant button to execute your position.
Monitor The Market
Keeping an eye on the market is key. Cryptocurrency is so volatile that your fortunes can change quickly. It’s a good idea to download a mobile app so that even while on the go, you can be ready to close a position. But remember, leave emotion at the door and stick to your perpetual swap strategy. Even the most level-headed traders can feel the urge to deviate, but keeping a clear head is vital.
Close The Trade
A perpetual swap does not expire, so when the time is right, close your trade and realise your profit or loss.
BitMEX was one of the first crypto derivative exchanges on the market, opening its virtual doors in 2014.
BitMEX is credited as the inventor of the perpetual swap contract, which are offered with up to 1:100 leverage on selected tokens. 19 coins are available to swap, including some interesting altcoins like Tron and Stellar alongside the big players: Bitcoin, Ethereum and Binance Coin.
OKEx is another popular exchange, founded in 2017 and based in the Seychelles. Like many perpetual swap exchanges, it operates its own liquidity pool and therefore offers a maker/taker fee structure. If you’re adding liquidity to the order book, your fees could be as low as -0.015% (i.e you receive a rebate), and if you’re taking liquidity away, the maximum fee is 0.05%. The fee is paid in addition to the funding rate. However, the funding rate is charged at 3 different intervals throughout the day 02:00, 10:00, and 18:00 (CEST, UTC +2). If you’re not holding a swap at this time, you won’t be charged. In this way, day traders can avoid paying for positions. Check out the OKEx perpetual swap guide for more information.
Final Word On Perpetual Swaps
Perpetual swaps are an exciting way to enter the cryptocurrency market without owning the underlying asset. We’ve provided you with a definition of how they work and a guide to getting started. But remember, these are risky instruments, so getting a clear risk management strategy in place is key.
How Do Perpetual Swaps Work?
Perpetual swaps are futures contracts with no expiry date.
They allow traders to open leveraged positions on cryptocurrencies, as well as hedge trades using short positions. They are a derivative contract and therefore their price is based on the underlying token’s value. Without an expiry date, perpetual swaps need a mechanism to keep their value in line with the asset’s. This is known as a funding rate – a fee or rebate based on whether you’re taking a long or short position and the value of the contract versus the asset.
Why Would I Trade Perpetual Swaps Vs Spot Crypto?
Spot crypto (i.e buying and owning cryptocurrency) allows traders to profit from a rise in price. This is your traditional ‘buy low, sell high’ scenario. However, experienced traders will look for opportunities to profit in all markets. Opening a short position on a perpetual swap means that when the price dips, the trader can make a profit.
Popular crypto exchanges, such as Binance and Coinbase, also offer the service, making it easier for those who’ve purchased spot through this channel to trade.Increasingly, exchanges that have traditionally offered derivatives only are now expanding into the spot market.
What Is A Perpetual Swap Funding Rate?
A funding rate is applied to a perpetual swap as a mechanism to keep its value in line with that of the underlying asset.Without an expiry date, perpetual swap contracts can diverge in price from the token they’re based on.The funding rate applies a fee or rebate to long or short positions depending on whether the value is too high or low.In this way, it encourages positions that will move the price closer to that of the asset’s market value.
Are Perpetual Swaps Worth It?
Perpetual swaps offer multiple benefits for experienced traders, including the ability to utilise leverage and hedge positions.