Perpetual Crypto Swaps, Any Idea?
One thing’s for sure, the numerous terms in the crypto space could get you confused. It’s almost like new terms come up everyday. And if you’re a newbie in the blockchain space, it becomes a whole lot more frustrating. One of such terms is perpetual swaps. They are currently the most popular form of crypto derivatives (CDs) trading in the DeFi ecosystem. Although similar to a typical futures contract, a number of key differences set perpetual crypto swaps apart.
So what in the world are perpetual swaps?
They are derivatives that let you trade the value of an underlying asset with no expiration dates. They are like futures trading where traders either long or short positions based on a certain future price of the underlying asset. However, perpetual contracts are different in the sense that they hold no expiration or settlement date.
Value, in a perpetual swap market is maintained by ensuring traders have a substantial amount of an asset as a form of collateral to back their orders.
Why do we trade them?
Picture this, you plan to speculate on a digital asset, say, Bitcoin or Ethereum. You are typically faced with three major options:
- Spot — here, you go to a crypto exchange, buy the amount of Bitcoin or Ethereum you desire using your fiat currency or other digital asset. You are directly buying the asset itself. The general rule of thumb is to buy low and sell high.
- Options — you could opt for an options contract where you have the right to buy or sell the digital asset at or before a specific predetermined time and at a set price. However, here you have to keep opening a new contract if you want to speculate on price movement after your previous contract expires.
- Futures — with a futures contract, you make an agreement to buy or sell an asset at a predetermined price at a specified time in the future. The drawback with this is, you’ll still need to open a new contract if you plan to continue speculating on the price of the asset after the expiration date.
All these are a range of options for you to choose from, however perpetual contracts stand out as a better option. Perpetual contracts provide a more comprehensive alternative in the sense that the contracts have no expiration or settlement date. You can hold it indefinitely and have no need of re-opening new contracts, as long as the contract doesn’t liquidate.
A funding rate mechanism is often used in the perpetuals market to ensure the perpetual swaps are kept close to the underlying price of the asset. The funding rate incentivises traders to open positions that go against the current trend, but in no way guarantees that actual outcome. Thus, if the funding rate is positive, long traders pay a premium to short traders. If it is negative, then short traders pay a premium to long traders. You guessed it, it’s a zero-sum outcome in perpetual contracts trading.
A major reason perpetuals are growing in popularity in the crypto space today is that they help traders to hedge and manage risks associated with trading. Whether the markets are going up or down, perpetual swaps allow traders to profit if they make the right trade. Thus smart traders take advantage of volatility. There are however quite a number of key terms to be aware of in the perpetuals market. These will be addressed in future posts.
Due to the rise in popularity of perpetual swaps and the immense market potential, CDzExchange will initially release decentralized perpetual swaps for traders in 2021 after our core MVP platform is live. It’s time to bring crypto derivatives to DeFi.