Price speculation without expiration
Perpetual futures contracts are derivative instruments that allow traders to speculate on cryptocurrency prices without owning the underlying asset directly. Unlike traditional futures contracts that expire on specific dates, perpetual contracts have no expiration date and can be held indefinitely. This means traders can maintain their positions as long as they meet the required margin and collateral requirements set by the exchange.
Perpetual contracts have become particularly popular in cryptocurrency markets for trading Bitcoin, Ethereum, and other digital assets with leverage. They offer higher liquidity compared to spot markets and enable traders to amplify their positions through borrowed capital from the exchange. The absence of an expiration date provides flexibility that appeals to both short-term speculators and longer-term position holders simultaneously. However, this flexibility comes with unique mechanisms like funding rates that keep contract prices aligned with underlying spot market prices.
Long positions vs short positions
A long position means a trader expects the asset price to increase and profits when prices rise above the entry point. For example, if Bitcoin trades at $110,000 and a trader opens a long perpetual contract, they profit when Bitcoin rises to $115,000. The trader buys the contract first at a lower price and sells it later at a higher price to realise gains.
Conversely, a short position means betting that the asset price will decrease, profiting when prices fall below the entry level. If Ethereum trades at $3,500 and a trader opens a short position, they profit when Ethereum drops to $3,300 or lower. Short positions involve selling the contract first at a higher price and buying it back later at a lower price. Traders can hold either long or short positions indefinitely in perpetual contracts, unlike traditional futures that force settlement at expiration. The long-short ratio across all positions indicates overall market sentiment, with ratios above 50% suggesting bullish sentiment generally.
Funding rates balance perpetual contract prices with spot market values
Since perpetual contracts lack expiration dates, exchanges use funding rates to keep contract prices aligned with underlying spot market prices. Funding rates are periodic payments exchanged between long and short position holders, typically occurring every eight hours on most platforms. When the perpetual contract price trades above the spot market price, long position holders pay short position holders through positive funding rates. When the contract price trades below the spot market price, short position holders pay long position holders through negative funding rates.
For example, if Ethereum perpetual funding is positive at 0.03% every eight hours, traders holding long positions pay this fee to shorts. These payments incentivise traders to take the less popular side, naturally pushing the contract price back toward the spot price. The funding rate mechanism creates a peer-to-peer system that maintains price alignment without requiring contract expiration or physical settlement.
