Ever since the arrival of Bitcoin in October 2008, the financial world has seen a revolution like never before. In many fundamental ways, cryptocurrency has questioned and changed significant fundamental factors in the financial sector. This does not only relate to fundamental, social or even policial subjects, but the way that exchanges operate and the way trading instruments have developed as well. In this article we will shed some light onto the invention that has changed trading forever.
Traditional markets vs Crypto currencies:
One of the most popular ways of trading cryptocurrencies is trading the futures markets. Futures enable traders to trade the assets underlying value without having the need to hold the actual assets. Therefore futures can also be traded on leverage. Futures are not unique to crypto markets. The way that they function however, differs greatly.
A key feature of traditional futures contracts is that there is an expiration date tied to it. Typically, traditional futures contracts expire on a monthly or quarterly basis. Whenever a contract expires, a process known as settlement begins. At the settlement date, the contract price converges with the underlying spot price, and all open positions expire and are closed. The amount of which the price diverges is what makes up a loss or a win on settlement date.
Cryptocurrency has brought over the futures markets to this new and revolutionary space, allowing people to trade on leverage, and invest without having the need to own the underlying asset, allowing for great flexibility. However, while taking all the good things from futures, it made it even better!
Perpetual futures were first proposed by economist Robert Shiller in 1992, to enable derivatives markets for illiquid assets. However, perpetual futures markets have only developed for cryptocurrencies, following their introduction in 2016 by BitMEX, and have since then become the norm in trading futures in the crypto industry.
Unlike conventional futures, perpetual futures allow traders to hold positions without an expiry date and therefore, eliminates their need to keep track of various settlement dates. For instance, a trader can keep a short position to perpetuity unless he or she gets liquidated. As a result, trading perpetual contracts have become very similar to trading pairs on the spot market, but with all the benefits that futures have to offer included.
Since perpetual futures contracts do not have a settlement date like in the traditional markets, a mechanism is needed to ensure that futures prices and spot prices converge on a regular basis. This mechanism is known as Funding Rates and is unique to cryptocurrency markets only at the time of writing.
Funding Fates are periodic payments either to traders that are long or short based on the difference between perpetual contract markets and spot prices. Therefore, depending on open positions, traders will either pay or receive funding.
Crypto Funding Rates prevent lasting divergence in the price of both markets, as increased funding rates can make it unfavourable to hold onto positions, and therefore proposes a self sustaining balancing mechanic without having the need to manually “reset” longlasting divergences in the market, and keeping the markets liquid. Funding is recalculated several times a day – Bitget Futures does this every eight hours.
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The information provided above is not financial advice but for educational and entertainment purposes. Please do your own due diligence or consult a financial advisor before investing in any digital assets.
All opinions expressed on Bitget’s Soapbox (also known as the ‘Soapbox’) are opinions of individual traders using the Bitget platform, and do not reflect the opinions of Bitget or its affiliate companies and partners. The Soapbox author’s opinions are based upon information they confirm to be reliable, but neither Bitget nor its affiliates warrant its complete accuracy, and it should not be relied upon as such.