Perpetual Futures 101

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We would like to take this opportunity to discuss the mainstream futures contracts in crypto market - perpetual futures.

Unlike CME traded traditional futures contract that settle on a monthly or quarterly basis, crypto exchanges have introduced an innovative futures contract called perpetual futures (or "perps"). These perpetual futures do not have an expiration date, allowing traders to maintain their positions indefinitely. This unique feature makes perps an attractive instrument for speculative traders to take leveraged bet on cryptocurrency markets. Some exchanges even offer leverage of up to 200x.

Since its launch in 2019, perps have been the mainstream futures products on crypto exchanges. The top 15 crypto exchanges trade over US$49bn in BTC perps daily, vs. a US$5bn daily volume for CME's BTC futures. As of 7 June 2024, the total open interest in BTC perps across the top 15 exchanges stood at US$31bn. vs. US$11bn on CME.

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Source: Coinglass as of 7 June 2024

 

So how does the Perps work? It uses a funding mechanism to ensure that the contract's price closely track the spot price of the underlying asset. The funding rate is a periodic payment exchanged between long and short positions to ensure that the contract price closely tracks the spot price and allow for continuous 24/7 trading. If the contract price is above spot price, long positions pay funding to short positions, and vice versa. Hence in a highly volatile market environment, it would be costly for maintaining positions.

 

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Source: Theblock

 

The funding rates could vary across different crypto exchanges (see charge above) due to the pricing index used and the funding time intervals etc., and this has created a popular arbitrage strategy for traders/market makers - cross exchange funding rate arbitrage.

Another popular arbitrage strategy is collecting funding payment. For example, in a bull cycle, the perps price could trade persistently above the spot price, resulting in a positive funding rate for long position holders. In this case, traders can short the perps, get the periodic funding payment for the position, while maintaining a long position in the spot market to keep market neutral. In the above chart, during the BTC bull run in Mar 2024, some exchanges were offering funding rates as high as 30-50% on BTC perps, this has created a significant profit opportunity for quantitative traders.