In 1992, economist Robert Shiller proposed a cash-settled futures market called perpetual futures that don’t expire and don’t provide delivery or coverage of the traded asset in order to lower the cost of rolling over or directly holding cryptocurrency contracts. However, such contracts are active only in cryptocurrency markets.
In order to gain exposure to an underlying asset or index, a trader can own a perpetual futures contract indefinitely. Since the contracts wouldn’t have a predetermined maturity date, this strategy allows for the creation of futures markets for illiquid assets. Furthermore, unlike equity futures, which are settled by delivering the asset at contract maturity, perpetual futures are always settled in cash — i.e., physical delivery.
In addition, as there is no asset delivery, perpetual futures facilitate trading with high levels of leverage. Leverage is a trading instrument that investors can use to increase their exposure to the market by enabling them to use borrowed funds provided by the broker to make a trade or investment.
Investors can hedge (mitigate risk) and speculate (increase exposure to price movements) on cryptocurrencies with high leverage by using perpetuals, which don’t require taking delivery of any crypto asset and don’t require rolling them over.
In essence, perpetual futures are a contract between long and short counterparties, where the long side must pay the short side an interim cash flow known as the funding rate, and the short side should give the long side some reward based on the futures price’s entrance and exit times.
Perpetual futures contracts’ prices are kept consistent with market values for the underlying assets they follow thanks to the funding rate mechanism. Funding takes place every eight hours — i.e., at 04:00 UTC, 12:00 UTC and 20:00 UTC. Traders can only pay for or get funding if they have a position at one of these times. The premium and interest rate make up the funding rate, which is determined based on the market performance of…