What Is a Perpetual Swap Contract?
Perpetual swap contracts are cryptocurrency derivatives that allow traders to hold long or short positions with sufficient margin. Perpetual swaps also allow traders to open large trading positions with a small deposit.
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Swaps provide traders with added flexibility, such as the ability to use leverage and settle contracts without the need for actual ownership or storage of the underlying asset. Although they are very similar to futures contracts, swaps differ from futures in two key ways, making them unique and popular trading instruments in the industry.
Futures contracts and swaps are both financial instruments that traders use to manage risk, but they differ in one key aspect – their time horizon. Futures contracts have a fixed expiration date, while swaps can last indefinitely, as long as the parties involved have enough funds to cover potential losses and avoid liquidation.
Another difference between futures contracts and swaps lies in the funding rate, which plays a significant role in maintaining the price equilibrium of indefinite swaps. Since there are no set expiration dates for swaps, exchanges use a funding rate mechanism to stabilize long and short positions by either encouraging or discouraging trades. In contrast, futures have predetermined expiration dates, and their prices automatically converge with the spot price of the underlying asset.
How are funding rates calculated?
The funding rate is determined by comparing the price difference between the swap contract and the spot price of the underlying asset. For instance, if the swap price is higher than the spot price, the funding rate becomes positive. This means that long position holders must pay a funding fee to short position holders as long as their positions remain open. On the other hand, if the swap price is lower than the spot price, the funding rate becomes negative. As a result, short position holders pay a funding fee to long position holders. The exact amount of the funding fee is calculated based on the size of each trader's position and their level of leverage.
Different exchanges have their own unique funding rate percentages which are paid at fixed time intervals. For some exchanges, the payment period occurs every eight hours.
Conclusion
Perpetual swaps are becoming an increasingly popular cryptocurrency derivative among traders due to their advantages, with daily trading volumes exceeding $180 billion.
With the high volatility of cryptocurrency markets and proper risk management, the correct use of perpetual swaps can potentially increase your deposit.
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