• More market exposure: Crypto perpetuals let you speculate on crypto price swings without owning the underlying assets, and provide leverage over the asset with little upfront collateral.
• Trade flexibly: Unlike traditional futures, perpetuals do not have expiration dates and are constantly settled, giving traders more flexibility for speculating and hedging.
• Funding rates: If a perpetual is trading higher than the spot price, long holders pay a fee to short holders, and vice versa.
• Risk management: Safe strategies like stop-loss orders and maintaining safe margins are essential when trading perpetuals.

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What Are Crypto Perpetuals?

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Perpetual futures, often dubbed "perpetuals" or “perps”, are one of the most dynamic instruments in the cryptocurrency trading scene. These derivatives let you bet on the price swings of cryptocurrencies without actually owning the underlying assets. And unlike traditional futures, which expire on a set date, perpetuals can be held indefinitely.

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As a result, perpetual futures have become a go-to tool for savvy crypto traders who want to stay nimble and engaged without the constraints of traditional contracts.

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Benefits of Trading Crypto Perpetuals

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Perpetuals can be much more than a trading tool; they offer flexibility, leverage, and the opportunity to hedge against market volatility.

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• Flexible Trading: With no expiry dates, you can hold your position as long as you want. —which can be perfect for a market as unpredictable as crypto.
• Increased Market Exposure: Perpetual futures allow you to amplify your exposure to the market with a smaller amount of capital. This capital efficiency potentially gives you more bang for your buck on your investments.
• Continuous Settlement: Perpetual futures use funding rates to maintain price alignment with the spot market, meaning perpetuals are settled continuously and eliminate the need for rollovers.
• Hedging Risk: If you’re holding a certain crypto, you can use perpetuals to hedge against adverse price movements, protecting your portfolio from volatility. For instance, if you’re holding Bitcoin you can use perpetual futures to short Bitcoin, offsetting potential losses if the price of Bitcoin drops.

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These features give perpetuals several benefits over traditional futures. Both perpetuals and futures let you speculate on crypto prices with or without leverage, but perpetuals let you stay instantly reactive and constantly up-to-date, as you experience real-time gains and losses without any time constraints or lock-up risks.

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How Do Crypto Perpetuals Work?

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Understanding the mechanics behind perpetual futures is crucial for any trader. Here’s a breakdown:

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• Funding Rate: The funding rate is a periodic fee paid between long and short positions. This mechanism keeps the perpetual’s contract price in line with the underlying asset's spot price.
• Mark Price: A perpetual’s mark price is used to calculate your unrealized profit and loss and is crucial for triggering liquidations. The mark price is usually calculated using a combination of the spot price and an average of the perpetual futures prices across different exchanges.
• Leverage: Leverage allows traders to amplify their exposure to an asset’s price movements. However, this comes with the risk of liquidation if the market moves against their position. In other words, using higher leverage can either amplify your returns or magnify your losses, making it a double-edged sword.
• Margin Requirements: When trading perpetuals, you must maintain a minimum amount of equity in your account—typically a portion of your total trade size. This amount is known as the margin. If the account’s equity falls below this level, your position can be liquidated to cover the losses.

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A Closer Look at Funding Rates

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How well you understand funding rates work can make or break your perpetual trading strategy, so let’s double-click into this crucial concept.

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To reiterate, funding rates ensure a perpetual contract price doesn't stray too far from the actual asset's price. While exact funding rates differ across different perpetuals, they are all periodic payments made between long and short-position holders, based on the difference between the contract and spot prices. 

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Thus, if the perpetual trades higher than the spot price, long holders pay a fee to short holders, and vice versa. It's a mechanism designed to keep trading balanced and prevent any wild pricing discrepancies.

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Funding rates aren't just plucked out of thin air. They're calculated based on current market conditions, including how much the perpetual price deviates from the spot price, plus a little extra for interest rates. If you’re trading perpetuals, keep an eye on their funding rates. This mechanism could pay you to hold a position when market dynamics align in your favor, but high rates can turn a winning trade into a break-even deal—or worse.

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Example: Trading Bitcoin Perpetuals

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The key concepts introduced above may seem a bit abstract, so let’s use a real-world example to see how they come together in an actual perpetual trade:Imagine you have $1,000 in your trading account and decide to trade Bitcoin perpetual futures with 5x leverage. This leverage means that for every $1 of your own money, you can trade $5 worth of Bitcoin. The current price of Bitcoin is $10,000.

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‍Position Size and Leverage

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‍With 5x leverage, your $1,000 allows you to open a position worth $5,000 (5 x $1,000). This means you can buy 0.5 BTC ($5,000 / $10,000).

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‍Mark Price and Funding Rate

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‍Let's assume the mark price is also $10,000 and the funding rate is 0.01% per 8 hours. Since your position is long (you're buying BTC), and the perpetual futures price is higher than the spot price, you will have to pay this funding rate to short position holders.

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‍Margin Requirements and Liquidation

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‍Your initial margin is $1,000, which is 20% of the total position size ($5,000). If Bitcoin’s price falls to $9,800, your position will be worth $4,900 (0.5 BTC x $9,800). Your loss would be $100 ($5,000 - $4,900), which reduces your equity from $1,000 to $900.

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Let's say the maintenance margin requirement is 10%. Your maintenance margin would be $500 (10% of $5,000). If your equity falls below this, your position could be liquidated to cover losses.

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‍Calculating Profit and Losses

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‍If the price of Bitcoin increases to $10,500, your position would be worth $5,250 (0.5 BTC x $10,500). Your profit would be $250 ($5,250 - $5,000), resulting in a 25% return on your initial $1,000 investment.

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However, you also have to pay the funding rate. If the funding rate is 0.01% per 8 hours and you hold your position for 24 hours, you pay three times (0.01% x 3 = 0.03%). On a $5,000 position, this equates to $1.50 (0.03% x $5,000). After subtracting the funding payment, your net profit would be $248.50.

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Managing Risk When Trading Perpetuals

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While perpetuals are a powerful tool within your arsenal, all financial instruments come with certain risks and must be used carefully. If you’re considering trading crypto perpetuals, be sure to mitigate your risk by doing the following:

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• Use Stop-Loss Orders: Stop-loss orders automatically close a position when the price reaches a certain level, limiting potential losses. They are crucial for managing risk, especially in volatile market conditions.
• Be Mindful of Margins: Maintaining sufficient margin is essential to avoid liquidation. Monitor your positions closely and ensure you have enough funds to meet margin requirements.
• Use Lower Leverage: While leverage can amplify returns, it also increases the risk of significant losses. Unless you are highly experienced, you may want to use leverage conservatively.
• Diversify Your Positions: Diversification can help spread risk. Instead of investing everything into a single perpetual position, you should consider diversifying your portfolio across different assets or employing various trading strategies.
• Stay Informed: The cryptocurrency market is highly dynamic and easily influenced by news, regulatory developments, and market sentiment. Staying informed can help you anticipate market movements and adjust your strategies accordingly.

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Closing Thoughts

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Whether you're a seasoned trader or a crypto newcomer, perpetuals offer a versatile way to tap into this exciting new market. But remember, in trading, as in life, there's no reward without risk—so trade wisely, start slow, and incorporate dollar cost averaging if you’re just getting started.

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