Introduction To Perpetual Futures In Crypto
Perpetual futures in crypto are very similar to futures contracts in that they allow you to bet on the future price of an asset without buying the asset itself. However, while futures contracts have set dates of maturity, crypto perpetual futures never expire unless you close the position.
And, while they have been around for decades, their emergence into the crypto world has gotten a lot of traction on the back of cheap and scalable networks like Arbitrum. But the potential for the sector is still largely untapped.
On September 18th, there was ~$74B of volume traded on perpetual futures. This is no small feat, but also a drop in the bucket when compared to $2T+ in futures volume on that same day.
Important Terminology To Know
Trading and perpetuals bring along a list of new terms and concepts to understand. So before we dive in, let’s make sure we have the basics covered:
- Long/Short: This is how a trader is positioned in the market at a given time. If you are long, you are bullish on the asset and expect it to go up. If you are short, you will profit from the price of the asset decreasing instead.
- Open Interest: The amount of open positions at any given time, measured in dollars.
- Funding Rate: Funding rates are one of the fees that you may pay for having a trade open, in addition to borrowing margin. Depending on how other traders are positioned, it can be more expensive to hold a position or you may even be paid to do so.
- Market Order: A way to open a trade instantly and secure the best possible fill price at that second.
- Limit Order: A conditional order, where your trade is only opened if the underlying asset falls or rises to a price set by the trader.
- Entry Price: The price in which you entered the trade, plus any fees paid.
- Liquation Price: The price where your assets and collateral will be forfeited to the platform.
Leverage In Perpetual Futures In Crypto
One of the reasons that perpetual futures have become so popular is due to leverage. These positions allow you to use your funds as collateral in order to take on a much larger position.
On many platforms, users are able to open leveraged positions up to 100x the value of their collateral. Sounds risky? It is.
That’s because you don’t get to lever up your position without anything in return. If you are using leverage and the trade starts to go against you, the trading platform will keep all of your collateral.
Avoiding Liquidation In Crypto
The more leverage that is used, the lower your margin of error on the trade can be.
Liquidation in perpetuals is calculated by a formula:
Liquidation = (100 / x) | where x = % of leverage used
This means that if you open up a 100x leveraged position, you can only take on a 1% pullback without your position being taken from you. But if you levered the position 5x, you would be able to survive up to a 20% drop before liquidation.
What We Did: Perpetual Trading
We opened up 3 unique trades, so Roaders could get the full experience. We will be closing these trades a week from now regardless of where they stand and reporting all the results back!
Note: These trades are for educational purposes and are independent of one another. The only time it would make sense to open up a leveraged short and hedge at the same time is when you are betting on one asset to outperform another.
Example: Long ETH and Short BTC: All else considered, this would be a short-term bet that ETH is going to outperform BTC.
Trade 1 – Speculating With A Long Position
- Asset: Bitcoin (BTC)
- Leverage: 10x
- Entry Price: $27,135.02
- Liquidation Price: $24,697.62
This trade speculates that the price of Bitcoin is going to rise. And if it does, we are reaping the benefits of holding $800+ of Bitcoin instead of the ~$80 that we opened the trade with.
Not a bad trade off considering it only cost us around $1 to open up this trade, and it is only costing us 70 cents / day to keep the trade open. This additional 70 cents is a borrowing fee that we pay for using leverage on the platform.
Trade 2 – Hedging Our Portfolio With A Short
- Asset: Ether (ETH)
- Leverage: 5x
- Entry Price: $1643.69
- Liquidation Price: $1,956.14
At this time ETH is the biggest position in our portfolio and the market is still very uncertain. Well, we’ve now protected our downside risk and can continue to hold our crypto by opening up this short position.
If Ether goes down in price, we will profit off of this position and can use those proceeds to accumulate more tokens at a cheaper price.
If the trade does not go our way, the upside from our ETH holdings will outweigh the loss from this trade. (Even if we are liquidated and lose the whole position)
Trade 3 – The YOLO Trade
- Asset: Uniswap (UNI)
- Leverage: 40x
- Entry Price: $4.39
- Liquidation Price: $4.324
Okay this one’s just for fun and so readers can see the volatility that comes along with high amounts of leverage. As a result, we opened up a very small position that we are more than okay losing. And we made a 2% return before I could even take the screenshot!
We followed up on our trades one full week later. You can see the results below:
Evaluating Our Trades
One week after opening each trade, here is where things stand:
Trade 1: The BTC Long
In the one week our trade has been open, the price of Bitcoin has gone from $27,135 to $26,215.
This ~3.5% decline has led our trade to be down by 40%+, due to the fact that we used 10x leverage on the trade and also had to pay fees.
Between trading costs and borrowing margin from the platform for a full week, we paid a total of $4.30 of fees on this position. While not a large dollar amount, it is important to note that fees in this case caused our position to lose an additional 5% of value.
Looking at the weekly price chart for Bitcoin, you can see that the timing of our trade was unfortunate and this trade spent almost the entire week out of profit.
Trade 2: The ETH Short
Due to the slight correction of the crypto markets over the last week, the hedge we made with ETH was our best performing of our three trades.
During this trade period, the price of ETH went from ~$1,644 down to $1,587. Even including fees, this landed us a 15%+ return, which was amplified by using 5x leverage on this position.
And if we had used the same amount of leverage as we did for our Bitcoin trade, we would have seen returns greater than 30%. All for a few dollars in fees.
Trade 3: The UNI Yolo
This position was opened with 40x leverage, meaning that Uniswap’s token was only allowed to drop by 2.5% this week in order for us to avoid liquidation.
Well, we learned that 2.5% is a very low margin of error. This trade was liquidated and went to zero in less than 36 hours.
As a result of being liquidated, our entire cost basis of $19.64 for the trade was taken by the platform. Be careful out there with leverage, Roaders.
What We Could Have Done Different
Now that we have reflected and learned from our trades, we wanted to introduce two concepts that could help our positions in the future.
Implementing A Stop Loss
Stop losses are a feature that is available on most trading platforms and can be incredibly valuable when it comes to protecting your downside or locking in profits.
Setting a stop loss allows you to determine the maximum loss you are willing to take on a trade upon the opening of the trade. Instead of holding a position until liquidation, you can choose a certain percentage or dollar amount that you are willing to lose.
If the trade goes against your favor and reaches this point, the trade will be automatically closed on your behalf. While you will avoid liquidation and losing the full collateral you put forward, you will still face losses and forgo any upside the trade would have realized after.
Lastly, you can also use a stop loss to effectively lock in profits by implementing one after the trade is already open. If you are sitting on unrealized gains and want to ensure that you lock in some profit, you can choose a certain level to automatically close your trade at.
Setting A Take Profit On A Trade
While stop losses protect a trader’s downside, take profits can be used to ensure that a trader is locking in gains when their trades are profitable. Take profits can be set at the time you open a trade or anytime after.
These allow you to determine a specific value or percentage gain that you are happy closing your trade with. If the conditions of your take profit are met at any time, your trade will be closed and you will be credited the predetermined gain.
In many cases, it will make sense to have a stop loss and a take profit active on a trade. This can allow you to position yourself accordingly and not have to constantly watch a price chart.
However, every trade is different and everyone has different risk tolerances, so always do what is best for your situation and goals.
Step By Step Guide: How To Trade Perpetuals
Trading perpetuals is similar to using a DEX, with a few additional things you need to be aware of. Perpetual trading interfaces also provide you with a lot of data and a price chart of the underlying asset.
GMX’s trading interface looks like this:
- The left side of the screen shows information on the asset, and a price chart that you can sort by time frame
- The right side is where you select the type of trade, asset you are trading, amount of the trade and leverage used
- After you input this information, GMX will show you what fees you will pay as well as when your position would be liquidated
- The bottom area is where your open positions would show up, as well as how they are performing
Once you confirm the trade, you will see this screen:
Risks & Considerations Around Perpetual Futures
Perpetual futures and leverage have the ability to bring a trader substantial returns and can also serve as a meaningful hedge in a portfolio. However, when used improperly, losses can add up very quickly and there are other concerns:
- Regulatory risks: The SEC and regulatory environment is not the biggest fan of perpetual futures and leverage. As a result, most of these platforms are not widely available in some countries and protocols carry greater risk.
- Liquidation risk: When you are trading with leverage, you can lose all of your assets and be forced to sell when you don’t want to. Reference the section above for how liquidations work with perpetual futures.
- Protocol-specific risks: With any DeFi protocol it is important to realize that crypto is still the Wild West. There are bad actors, hackers out for blood and protocols that mean well, but cut corners.
As we continue our public wallet journey, readers can track our wallet on their own through DeBank. Simply go to their site, paste in our wallet address and follow our journey in real time under “portfolio”.
Here is the Milk Road Public wallet address:
This report is for informational purposes only and should not be relied upon as a basis for investment decisions, nor is it offered or intended to be used as legal, tax, investment, financial or other advice. You should conduct your own research and consult independent counsel on the matters discussed within this report. Part performance of any asset is not indicative of future results.
It should also be noted that the writer(s) of this report may hold assets mentioned in the article at the time of writing.