The crypto investor’s guide to perpetual swaps

Perps offer powerful advantages to qualified traders seeking to dominate both sides of crypto’s volatile market

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Blockworks guide to perpetual swaps

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For qualified* cryptocurrency market participants with either a higher appetite for risk or a requirement to hedge digital asset positions, utilizing derivatives is a popular strategy. 

Diving into the mechanics and advantages of these crypto derivatives, this article demystifies how one such derivative, perpetual swaps (“perps”), allow qualified* traders to harness the volatility of digital assets without directly holding them. From understanding the leverage they offer to grasping the significance of the funding rate, we’ll explore why perps have become a pivotal tool in the evolving landscape of cryptocurrency trading.


Key Takeaways:

  1. Perpetual swaps, or “perps”, let institutions express their view on digital asset prices without holding the actual cryptocurrency, offering cash settlements and no expiration dates for greater flexibility.
  2. The intended purpose of the funding rate is to keep the perpetual swap price closely aligned with the underlying asset’s value, but how it’s calculated and applied by trading venues has a critical impact on the trader’s experience. This is because wild swings in funding rates can reduce confidence in the venue and potentially negatively impact the trader’s position.
  3. These swaps offer institutions* a relatively simple path into the crypto market, minimizing the operational challenges of holding digital assets and enabling familiar fiat currency settlements.

What are perps and what makes them attractive?

Like futures, perpetual swaps offer qualified* institutional market participants the ability to express their views of potential price movements on an underlying digital asset using leverage without incurring the operational and security risks associated with holding physical crypto. 

Simply put, the trader can trade on the price movement of a digital asset, margin the

position, and settle the trade in cash.

Perps are like futures in that leverage is generally available, but there is no expiration

date. Instead, the contracts roll forward indefinitely and providers of perpetual swaps

employ a “funding rate” to keep the price of the contract close to the price of the

underlying asset. The funding rate is a periodic payment that is made between long and short positions, based on the difference between the price of the contract and the price

of the underlying asset.

How perps stack up against dated futures | Artwork by Crystal Le

The Perpetual Swaps are attractive products because they exhibit similar characteristics and have similar use cases to products found in traditional markets. They can be summarized as follows:

Leverage

One of the most compelling attributes of derivatives is the leverage they afford. This financial tool enables traders to commandeer significantly larger positions with just a fraction of the required capital. While this presents an enticing avenue to amplify potential profits, it’s a double-edged sword. While levering up can potentially increase gains, the risks of magnified losses loom equally large, necessitating prudent decision-making.

Hedging

Perps shine as instruments of hedging, often utilized as a means to reduce exposure to price volatility. Illustratively, consider a trader invested in spot Bitcoin. To guard against potential downturns in Bitcoin’s price, they might opt to sell a Bitcoin perpetual swap contract. This strategic move hedges their position, providing a buffer against adverse price movements.

Liquidity

The world of perpetual swaps is characterized by its abundant liquidity. This robust liquidity means that even sizable trades can often be executed swiftly and efficiently. Slippage or market disruptions are of course possible in the crypto perps markets (this should be nothing new, as such disruptions happen in “TradFi” markets as well). That said, if the trend of large-scale institutions adopting digital assets as a part of their strategy continues, it is likely liquidity will continue to improve over time – drawing more participants and deeper order books.

The significance of the funding rate

Understanding the concept of a funding rate is crucial for anyone trading perpetual swaps. Most active participants on crypto exchanges recognize that the funding rate is primarily dictated by the difference between the perpetual price and the underlying spot market, commonly linked to a specific index. 

This rate acts as a balancing force, attracting sellers when the perpetual price rises above the spot market, and vice versa for buyers. The success of this mechanism relies heavily on the continuous engagement of market participants in the perpetual market to maintain price consistency. While the system is often effective at facilitating seamless cryptocurrency transactions, there are occasions when market prices can diverge significantly, underscoring the ever-volatile nature of digital assets.

In general (but not always):

Perps and Funding Rate | Source: CoinGuides

Institutional* market participants have telegraphed their interest in trading on venues where the perpetual swap funding rate reflects a value close to the venue’s actual borrowing costs, meaning the rates are not directly tied to the rates that are predominantly displayed on large-scale/retail crypto trading platforms, thereby minimizing the potential for excessive fluctuations of the funding rate. A funding rate might be meticulously computed by integrating elements like T-Bills, adding a markup tailored for USD financing, and juxtaposing it with the prevalent market borrowing rate designated for digital assets. 

However, it’s noteworthy that in the volatile domain of crypto, positioning and overarching funding markets might not always align seamlessly. When these markets diverge, it invariably impacts the funding rate, emphasizing the ever-evolving nature of digital asset trading.

The critical role of a venue’s funding rate calculation

The method a trading venue employs to calculate its funding rates can significantly influence its market reputation and trader trust. For trading venues aspiring to introduce a perpetual swap contract without frequently subjecting their clientele to the volatile (and often unpredictable) funding rate fluctuations common in leading exchanges, it’s imperative to leverage their robust, scalable pricing mechanisms. 

These mechanisms should span both spot and derivative markets and incorporate a flexible financing fee, catering to both long and short positions. The determination of this variable fee is often rooted in various factors: insights from traditional futures markets, the prevailing costs associated with borrowing digital assets, strategic market positioning, the set margin requirements, and the established credit relationships with trading partners. By prioritizing precise funding rate calculations, trading venues may foster more transparent, and efficient trading environments for their users.

In the fast-paced, ever-evolving world of cryptocurrency, perpetual swaps stand out as an advanced beacon for traders seeking to navigate the tumultuous waters of digital assets. This guide has illuminated the intricate mechanics and potential advantages of perps, revealing why they are widely considered to be a cutting-edge crypto strategy. 

By utilizing these derivatives, traders can employ leverage, hedge against uncertainties, and obtain deep liquidity, all without wading into the operational complexities of holding physical crypto. 

As the digital finance landscape continues its onward march, it should be expected that new and innovative financial products will be brought to market. Qualified* market participants may want to consider the use of perpetual futures products offered by reliable venues as a means to further hone their strategy and manage their risks.

This content is sponsored by BlockFills


At BlockFills, the team is committed to advocating for the proliferation of digital assets through the traditional financial system. However, they also understand that many firms who desire exposure to this asset class may be required to move into the market cautiously due to the existence of financial, operational, regulatory, and reputational risks. Perpetual swaps and related products may provide a means for qualified* institutions to gain exposure to the asset

class by posting collateral and performing all settlements in a way that they are already

very familiar with—fiat currency.

Perpetual Swaps are provided to institutional* clients via BlockFills’ UK-based, FCA-regulated affiliate, Basis Capital Markets UK Limited. Basis’ crypto “perp” offerings are powered by a strategic partnership with BlockFills, whose bespoke, end-to-end technology and cryptocurrency trading solutions including the multi-asset, trading and execution platform, Vision Trader, the sophisticated, industry-leading front-end platform, Phoenix, and reliable, 24/7 market access through BlockFills’ FIX API. The BlockFills electronic trading venue optimizes liquidity across fragmented markets by applying aggregation and matching algorithms and simplifying the trade management lifecycle for institutions. 


BlockFills Disclaimer:

The information in this document is not to be construed as an offer to sell or a solicitation or an offer to buy contracts for difference (CFD), cryptocurrencies, futures, swaps, foreign exchange, or options on the aforementioned.  All information contained herein is believed to be accurate, Reliz Ltd makes no representation as to the accuracy or completeness of any data, statistics, studies, or opinions expressed and it should not be relied upon as such. The risks of trading can be substantial. Each investor must consider whether this is a suitable investment. Before trading one should be aware that with potential profits there is also potential for losses that may be very large. Contracts for difference (CFD), cryptocurrencies, futures, swaps, foreign exchange, and options trading is highly speculative in nature and involves substantial risk of loss, and is not appropriate for all investors. Those acting on this information are responsible for their own actions. Past performance is not indicative of future results.  

*Derivative Products available to Qualified Counterparties Only. For US Persons, client is an Eligible Contract Participant (“ECP”) as defined in Section 1a(18) of the Commodity Exchange Act and related guidance. Non-US Persons must qualify as an Eligible Professional Client.

Basis Capital Markets UK Ltd. is authorized and regulated by the Financial Conduct Authority (Firm Reference Number 810733).

Basis Capital Markets UK Ltd. is registered in England and Wales at 70 Pall Mall, London, SW1Y 5JG, United Kingdom (Company Number 09882444).



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