What Are Perpetual Futures and How Do These Crypto Derivatives Work?

What Are Perpetual Futures?

Perpetual futures are derivatives that let you speculate on the price of crypto without actually owning that crypto. A derivative is a contract whose value depends on something else, in this case, for example, the price of a crypto.

Perpetual futures are also called perpetual swaps or perps. The main difference versus regular futures is that perps do not have a fixed end date. So a position can stay open until you close it yourself, or until a crypto exchange liquidates the position because there is not enough collateral left.

These contracts are usually cash-settled. That means when you close the position, you do not receive crypto and you do not have to deliver crypto. The profit or loss is settled in the currency of the contract or in the crypto used as collateral.

A perp tracks the price of an underlying crypto, but it is not the same as buying that crypto. For example, someone who opens a long position on a Bitcoin perp does not own Bitcoin. They only have a contract whose value goes up or down with the price movement.

Because a perpetual future has no expiration date, an extra mechanism is needed to keep the contract price close to the spot price. The spot price is the current price at which you can buy or sell crypto right away. That mechanism is called funding and it consists of periodic payments between traders.

Note: Perpetual futures are complex derivatives and come with a high risk of loss. Because of leverage, small price moves can have big consequences for your position and you can quickly lose your posted margin. Your position can be automatically liquidated. This article is for informational purposes only and is not investment advice.

Key Takeaways

• Perpetual futures are contracts that let you trade crypto price moves without owning the underlying crypto.
• A perpetual future has no fixed end date and can stay open until you close it or you get liquidated.
• You can go long if you expect prices to rise and go short if you expect prices to fall.
• Margin and leverage let you open a bigger position than your collateral, but they also increase risk.
• Funding rates help keep the price of a perpetual future close to the spot price.

How Do Perpetual Futures Work?

Perpetual futures work by you choosing whether you think the price will go up or down, and then your profit or loss moves along with the market price of the contract. If you expect a rise, you open a long position. If you expect a drop, you open a short position.

To open a position, you deposit margin. Margin is the collateral you keep available in your account to cover potential losses. With that collateral, you can often open a position with a higher total value. This is called leverage.

Say you use €100 as margin to open a position worth €1,000. You are then trading a position that is ten times larger than your deposit. A price move therefore applies to the full €1,000 position, not just the €100 you put in.

The crypto exchange constantly values an open position using a mark price. The mark price is a price reference used, among other things, to calculate your ongoing profit or loss and to check whether you still have enough margin. This price can differ from the last price traded on a chart.

Your ongoing profit or loss is also called unrealized PnL. PnL stands for profit and loss. The loss or profit is only realized when you close the position or when it is closed through liquidation.

A perp does not need to be rolled into the next monthly or quarterly contract. Still, a position cannot just stay open safely forever. Funding rates, trading fees, and changing margin requirements can reduce your available margin. That can increase liquidation risk.

The exact rules vary by contract and crypto exchange. So always pay attention to the underlying price index, contract size, collateral, maximum leverage, funding interval, and margin rules.

What Are Funding Rates?

Funding rates are periodic payments between traders with a long position and traders with a short position in perpetual futures. So it is not a fixed interest rate that always goes to the crypto exchange.

When the price of a perp is higher than the spot price, the funding rate is usually positive. In that situation, longs pay shorts. That makes a long position less attractive and a short position more attractive, which can move the contract price back toward the spot price.

When the perp price is below the spot price, the funding rate is usually negative. Shorts then pay longs. This also gives traders an incentive to push the contract price back toward the spot price.

The funding payment depends on the total value of your position and the funding rate. In simple form, that is:

funding payment = position value × funding rate

The position value is the total value of your open position. The funding rate is the percentage that applies for that interval. Say your position is worth €1,000 and the funding rate is 0.01%. Then the funding payment is €0.10. Whether you pay or receive that amount depends on the direction of your position and the sign of the funding rate.

The funding rate is not a reliable signal that the crypto market will go up or down. Positive funding does not automatically mean the price will drop, and negative funding does not automatically mean the price will rise. But long periods of unfavorable funding can significantly impact your results, especially with a large position.

The funding interval also differs per crypto exchange. Some platforms apply funding every hour, while others use an eight-hour interval. So check not only the rate, but also how often it is applied.

What Benefits Do Perpetual Futures Offer?

Perpetual futures mainly offer flexibility for traders who want to trade crypto price moves without owning the underlying crypto.

• No fixed end date: You do not have to close or roll a position because a contract expires.
• Go long and short: You can trade both rising and falling prices.
• Trading with margin: With margin and leverage, you can open a larger position with a relatively small deposit. The notional value is the total value of that position, while your margin is the amount you actually post as collateral.
• Continuous trading: Many perpetual markets are available 24/7, just like the crypto market itself.
• No physical delivery: Profits and losses are typically settled financially. You do not need to receive or deliver the underlying crypto.

These features are not a benefit for every trader. Leverage can make a position possible with less collateral, but it also increases losses and the chance of liquidation. Available markets, maximum leverage, and terms also vary by crypto exchange and jurisdiction.

What Risks Do Perpetual Futures Have?

Perpetual futures are risky investment instruments because crypto price moves and leverage can quickly amplify losses. A relatively small move against you can already eat up a big part of your margin.

Key risks include:

• Volatility: Crypto can rise or fall sharply in a short time. With leverage, that move applies to a larger position value.
• Liquidation: A crypto exchange can automatically close your position entirely or partially when your margin no longer meets the required minimum buffer.
• Funding costs: If you are on the paying side of funding, you can face extra costs. That reduces your available margin.
• Market and execution risk: In fast markets, the mark price can change quickly. An order may execute later or at a worse price than you expected.
• Platform and protection risk: Consumer protections and derivative rules vary by product, provider, and country. A license or registration does not remove price, liquidation, and operational risks.

Perpetual futures with leverage can fall under the rules for CFDs. ESMA has indicated that this is likely the case when the product meets the definition of a CFD. A CFD is a contract where you settle the price difference between opening and closing, without owning the underlying product. If a perpetual future qualifies as a CFD, rules may apply for things like maximum leverage, automatically closing positions when margin is too low, negative balance protection, and required risk warnings. Which rules and protections apply depends on the product, the provider, and the applicable regulations.

How Does Liquidation Work in Perpetual Futures?

Liquidation is the automatic closing of some or all open positions when there is not enough margin available to cover potential losses. It is a risk measure by the crypto exchange to prevent a loss from growing beyond the available buffer.

For an open position, there is usually a minimum buffer: the maintenance margin. This is the minimum amount of margin that must remain to keep the position open. If your available margin falls below that, liquidation can follow.

With isolated margin, you assign a separate amount to one position. With cross margin, available collateral can be shared across multiple positions. Because of that, with cross margin the condition of your whole account can affect the liquidation risk of one position.

The liquidation price is the estimated price at which the crypto exchange can step in. This price is not always fixed. Extra collateral, funding, trading fees, the size of your position, other positions, and changed margin rules can change the liquidation price.

An important nuance is that liquidation often uses the mark price and not the last traded price on the chart. Because of that, a position can be liquidated even while the visible last price does not seem to clearly hit the liquidation price.

Example: Say you are long and the mark price drops below the liquidation threshold. The crypto exchange can close your position because your margin is insufficient, even if the last traded price on your chart is just above that threshold.

Some systems first try to reduce risk by closing part of the position. Liquidation fees may also apply. The exact process differs per crypto exchange.

A stop-loss can limit losses, but it does not guarantee liquidation will be avoided. A stop-loss can react to a different price reference than the mark price, execute later, or execute at a worse price in a fast market.

Why Does Leverage Increase Risk?

Leverage increases risk because you control a much larger position with a small amount of margin. That means every percentage price move counts across the full position value, while your collateral is only a part of it.

Take the €1,000 position with €100 margin again. If the position drops 5%, the loss is €50. That is 5% of the position value, but already 50% of your original margin. Without leverage, a 5% price drop would also cost about 5% of your invested amount.

The higher the leverage, the smaller the buffer against an unfavorable price move. The liquidation price is then usually closer to your entry price. Funding rates and trading fees can shrink that buffer even more.

There is no fixed rule of thumb where, for example, 10x leverage always leads to liquidation exactly after a 10% drop. Maintenance margin, mark price, fees, funding, the chosen margin mode, and risk limits all affect the real liquidation point.

Whether a loss can become larger than the originally posted collateral depends on the crypto exchange’s terms and any negative balance protection. So do not automatically assume your loss is always limited to your first deposit.

What Is the Difference Between Perpetual Futures and Traditional Futures?

The main difference is that traditional futures have a fixed expiration date and perpetual futures do not. A traditional future has to be closed before or on the expiration date, rolled into a later contract, or settled.

With traditional futures, settlement can, depending on the contract, involve financial settlement or physical delivery of the underlying product. Around expiration, the price of such a contract typically moves toward the relevant settlement price.

A perpetual future has no fixed end date. So you do not have to keep replacing the contract with a new contract. Instead, funding rates help keep the contract price close to the current crypto price.

Both traditional futures and perpetual futures can use margin and leverage. So the lack of an end date does not make perpetual futures less risky. A position can still lose money, rack up funding costs, or get liquidated.

Also, perpetual does not mean a position can stay open indefinitely under all conditions. A crypto exchange can suspend a market under special circumstances or settle a contract early according to its terms.

How Can You Trade Perpetual Futures Responsibly?

Trading perpetual futures responsibly starts with fully understanding and setting limits on your risk upfront. Follow these steps before and while you trade.

1. Read the contract specs

Check which crypto the price index tracks, how the mark price is determined, how often funding is calculated, and which funding formula applies. Also review the contract size, fees, margin mode, maintenance margin, liquidation rules, and maximum leverage. These rules determine how your position works in practice.

2. Choose a limited position size

Do not only look at how much margin you can deposit, but mainly at the total notional position value you are opening. Limit that value and use conservative leverage, so a normal unfavorable move in the crypto market does not immediately wipe out your entire margin.

3. Check funding and margin

Before opening a position, look at the funding rate, the funding interval, your available margin, and the estimated liquidation price. Check this during the trade too, because funding, fees, and price moves can change your buffer.

4. Set your exit conditions ahead of time

Decide in advance when you will take a loss, take profit, or reduce your position. A stop-loss can be part of that plan, but it is not a guarantee against losses or liquidation. Account for fast price moves and potentially unfavorable execution.

5. Only use money you can afford to lose

Only trade with your own money that you can afford to lose. Do not use a product or strategy you do not understand. Perpetual futures can quickly lead to large losses, even when your position initially seems small.

6. Check the product protections

Before you trade, check whether the provider is allowed to offer the product to you and what protections apply to you. Rules and protections can differ by product, client type, and jurisdiction.

These steps reduce risks, but they do not make perpetual futures safe. Slippage, outages, sharp price moves, and liquidation can still cause losses. Slippage means an order is executed at a worse price than the price you expected.

Final thoughts

Perpetual futures are crypto derivatives that let you trade both rising and falling prices without owning the underlying crypto. The standout feature is that these contracts do not have a fixed expiration date. Funding rates help keep the perp price close to the spot price.

The flexibility of long and short positions, cash settlement, and continuous trading can be appealing, but margin and leverage also make the product complex and risky. A small price move can have a big impact on your margin because of leverage. Funding costs, mark price, and liquidation rules can increase that risk even more.

So if you want to use perpetual futures, you should first understand how the specific contract works, limit position size and leverage, and actively keep an eye on available margin, funding, and the liquidation price. Only trade with money you can afford to lose, and treat a stop-loss as a tool, not a guarantee.