What are futures and perpetual contracts (perps) in crypto trading and how to use them

Derivatives contracts in crypto trading are investments that get their values based on an underlying cryptocurrency, such as bitcoin or ether. These contracts allow traders to speculate on the cryptocurrency's price movements without owning the asset directly. 

Common types of crypto derivatives include but are not limited to futures and perpetual contracts. 

What are crypto futures? 

Unlike spot trading in crypto, where the asset can change hands immediately, futures contracts are agreements whereby the one "short" the contract is obligated to deliver the asset to the one "long" the contract at a set price on a future date. This can be particularly advantageous for those seeking to hedge against market volatility or leverage their positions to amplify returns.

However, crypto futures carry significant risks due to the high volatility of cryptocurrency prices, which can lead to rapid and substantial losses, especially when using leverage. The potential for market manipulation and low liquidity can exacerbate these risks, making it difficult to exit positions at favorable prices.

What are perpetual contracts?

Perpetual contracts, also known as "perps," are futures contracts that essentially lack an expiration date. This allows traders to hold a position indefinitely — provided they can maintain the necessary margin and account for the funding rate, which is a fee paid periodically to balance the price of the perpetual contract with the spot price.

The funding rate ensures that the trading price of the perpetual contract remains tied to the underlying asset's market price. Traders involved in perpetual contracts must be vigilant about market movements and funding rate intervals — often as short as eight hours — to manage their positions effectively.

While traditional futures have a set expiry and settlement date, perpetual contracts continuously roll over. This means traders in perps can avoid the constraints of time-bound contracts and have the flexibility to respond to ongoing market developments. Traders looking to capitalize on short-term price movements find perpetual contracts particularly appealing. 

How does one use futures and perps in crypto trading? 

Investors can use futures contracts and perps in crypto trading for speculation and hedging.

By taking long or short positions in these contracts, they can bet on the future price movement of cryptocurrencies without holding the underlying assets. This allows investors to profit from rising (when long) or falling (when short) markets.

Beyond speculation, investors can also use these contracts for risk management and portfolio diversification. By hedging their positions, they can protect against adverse price movements in the underlying cryptocurrency, such as shorting futures to offset potential losses from holding the actual asset. Additionally, futures and perps provide exposure to a broader range of assets, enabling investors to diversify their portfolios without owning the cryptocurrencies themselves.