What are perpetuals and how do they work?

At their core, perpetual contracts (often just called “perps”) are derivatives that let you speculate on an asset’s price, rising or falling, without owning the asset.

Like standard futures, perpetuals let traders speculate on the future price of assets such as Bitcoin or Ethereum without owning the underlying asset. However, unlike traditional futures, perpetuals have one defining feature; they never expire.

 

You can hold your position for as long as you like, provided you meet the margin requirements.

 

Futures vs. perpetuals: What’s the real difference?

Traditional futures have a fixed expiry date so they lock you into a settlement date, meaning you either roll over the contract or close it when it expires.

 

This expiration marks the point when the contract is settled against the asset’s current (“spot”) price. For traders, this means regularly “rolling over” positions to maintain exposure, a process that’s both time-consuming and costly.

 

Perpetuals remove this problem entirely by eliminating the expiry date. Instead, they use a continuous financial mechanism to keep prices aligned with the spot market: the funding rate.

 

Instead, they use a funding rate: a mechanism that keeps the price of the perpetual contract aligned with the spot price of the underlying asset.

 

When the contract trades above the spot, long position holders pay shorts; when below, shorts pay longs. A clever balancing act.

• Positive funding rate: When the perpetual trades above the spot price, long traders pay short traders. This discourages new longs and encourages shorts, bringing prices back down.

• Negative funding rate: When the perpetual trades below the spot price, short traders pay long traders, pushing prices back up.

This mechanism keeps perpetual contracts aligned with the underlying asset, achieving the same result as traditional futures but without expiry or rollover.

 

How do they work in practice and what makes them tick?

Leverage and margin: Perps often allow traders to use high leverage; sometimes 10×, 50×, even 100×. That means you can control a big position with a small amount of capital. But let’s not sugarcoat it: high leverage also means high risk.

Initial margin and maintenance margin: To open a position, you post initial margin. As the market moves (and moves it will), your maintenance margin acts as a buffer. If your equity goes below this level, your position gets liquidated.

Funding rate: This small payment between traders updates every few hours (depending on the exchange). It keeps the contract price close to the spot price. It may seem minor, but ignoring it can quietly eat into your profits.

Liquidation mechanism: If your leveraged position moves against you and your margin drops below the maintenance level, the platform automatically closes it. Some exchanges also use insurance funds or auto-deleveraging (ADL) to protect the system.

 

Why are perpetuals coming for Wall Street?

Traders use perpetuals for two main purposes:

• Speculation: High leverage lets traders profit from small price moves, driving roughly 90% of crypto trading volume.

• Hedging: Professional funds maintain long-term synthetic positions without the hassle of rolling over traditional futures, simplifying portfolio management.

Exchanges facilitating perpetuals do more than match buyers and sellers; they manage risk and maintain market stability.

• Insurance funds: Exchanges hold insurance funds to cover losses if a liquidated position can’t be closed at the bankruptcy price.

• ADL: If insurance funds fall short, ADL triggers, reducing positions of profitable traders to prevent catastrophic losses and maintain stability.

 

What can go wrong?

Perpetuals carry several key risks that traders need to understand.

 

High leverage means that even a small market move against your position can quickly wipe out your margin, creating significant liquidation risk.

 

The funding rate, often overlooked, can gradually eat into your gains or amplify losses over time.

 

Volatility is another factor: these instruments are inherently risky, and in fast-moving markets, conditions can shift from manageable to disastrous in an instant.

 

Finally, there is counterparty and exchange risk, as some markets may lack transparency or proper regulation, making it crucial to verify your exchange’s reputation and risk controls before trading.

 

That’s why Toobit launched its $50 million Shield Fund, a fully financed safety net protecting all users from platform-related losses. Coverage is automatic, whether assets are traded, staked, or held, and requires no sign-up or fees. 

 

In an industry prone to hacks and exchange failures, the fund underscores Toobit’s commitment to user safety.

 

Final thoughts

Perpetual contracts are powerful, flexible, and widely used, especially in crypto. They’ve carved out a niche thanks to their no-expiration model, leverage options, and alignment with spot markets.

 

But that power comes with risk. If you’re thinking of trading perps, learn the mechanics, manage your leverage, mind the funding rates, and always assume the market can bite back.

 

To know more on how to trade perpetual contracts on Toobit, click here.