Market basics

Spot, futures and perpetuals: what you own, and what can take it

The same chart can be traded three ways, and the three are not variations on one thing. One buys an asset. Two buy an agreement about an asset. Only the second kind can be taken away from you while you are right.

About 12 minutes to read. Free, no account.

Spot: you own the coin

A spot trade exchanges money for the asset, now. Afterwards you hold the coin. There is no expiry, no ongoing payment and no level at which anybody closes your position for you. If it falls 90% you still hold every unit you bought.

Your risk is simple and total: the asset can go to zero, and whoever holds it for you - an exchange, a wallet, a custodian - is a separate risk from the price. "Not your keys, not your coins" is about this second kind, and it is not a price risk at all.

Spot can be leveraged too, by borrowing, which is called margin trading. The moment you borrow, the paragraph above stops being true and the rest of this lesson applies to you.

Futures: an agreement, not an asset

A futures contract is an agreement to settle the difference between an agreed price and a future price. You never hold the coin. In crypto almost all of these are cash-settled: at expiry the difference is paid in the quote currency and the contract is gone.

Two consequences follow immediately. First, you can be short as easily as long, because there is nothing to borrow - you are simply on the other side of an agreement. Second, you post margin, which is collateral against the agreement rather than a purchase price. The size of the agreement is called the notional, and it is much larger than the margin.

A dated future also carries a basis: its price differs from spot because it is a price for a different date. The basis converges to zero at expiry, by definition, since on the settlement day the two dates are the same day.

Perpetuals: a future with no expiry, held together by funding

A perpetual swap is a futures contract with no settlement date. That creates an obvious problem: with no expiry, nothing forces its price back to spot. The fix is a periodic payment between the two sides called funding.

When the perpetual trades above the index, longs pay shorts; when it trades below, shorts pay longs. The payment makes the expensive side of the trade cost something to hold, which is what keeps the contract tethered. Most venues settle it every eight hours, and the rate is charged on your notional, not on your margin.

What funding actually costs to hold

notional                      10,000
funding rate     0.01%  every 8 hours

one payment      10,000 x 0.0001   =  1.00
payments per day 24 / 8            =  3
per day          3 x 1.00          =  3.00   (0.03% of notional)
per 30 days      30 x 3.00         =  90.00  (0.90% of notional)

annualised       0.03% x 365        =  10.95% of notional per year

That is a rate people describe as "small". It is roughly eleven percent a year of the position size, and funding rates in an excited market run several times higher for days at a time. Funding is a holding cost, so it is the direction-neutral part of your result and it never stops accruing.

Leverage is a ratio, and its arithmetic has no opinion in it

Leverage is one division: the notional of the position divided by the margin behind it. It is not a feature you switch on; it is a description of a relationship between two numbers you chose.

The two lines of arithmetic that are all leverage is

margin                 1,000
notional               5,000
leverage      5,000 / 1,000   =  5

price moves against you by 2%
loss on notional   5,000 x 0.02   =  100
as a share of margin   100 / 1,000  =  10%

the general rule:  margin move  =  price move  x  leverage

A two percent move became a ten percent move in the only account that matters, and it works identically in both directions. The market is unaware of your leverage - the coin moved 2%, and the multiplication happened entirely inside your account.

We will not tell you what that number should be, here or anywhere else. It depends on things we do not know and should not guess at, and the arithmetic above is the whole of what we can honestly give you. See the risk disclaimer.

Liquidation: the level where somebody else closes your trade

Because the margin is smaller than the notional, there is a price at which the losses would exceed the collateral. The exchange cannot allow that, so it closes the position first. This is liquidation, and the level is arithmetic, not a judgement.

The rough shape: your equity is the margin minus the loss so far, and the exchange steps in when equity falls to the maintenance margin - a small fraction of notional it insists remains.

Where the position is closed for you

margin                      1,000
notional                    5,000
maintenance margin  0.5% of notional  =  25

loss that can be absorbed   1,000 - 25   =  975
as a move on notional       975 / 5,000  =  19.5%

so an adverse move of about 19.5% closes the position
and without the maintenance requirement it would be 20.0%

Three honest refinements, because the number above is a model and not a quote from an exchange:

Exchanges compute maintenance margin on the current notional, which shrinks as price falls, and they apply tiered rates that rise with position size. Expect the real level to differ from a hand calculation by a fraction of a percent.
Liquidation is usually triggered on the mark price, which is anchored to an index of several venues. That protects you from one venue’s wick and means the price on your own chart is not the one being measured.
Fees and accrued funding come out of the same equity, so they move the liquidation level closer to you the whole time the position is open.

What each of the three can and cannot do to you

Spot, unborrowed - no expiry, no funding, no liquidation. You hold the asset and the custody question. Being right eventually is possible.
Dated futures - no funding, but an expiry that ends the trade whether you are finished or not, plus margin and liquidation.
Perpetuals - no expiry, but funding every few hours and liquidation. Being right about direction and wrong about when is a losing trade here even without a liquidation.
All derivatives - you own a claim on an exchange, not a coin. Exchange solvency, auto-deleveraging and socialised losses are real mechanisms and they are nothing to do with price.

The point of separating them is not that one is better. It is that they fail differently, and the way an instrument fails is part of the instrument.

The terms, defined

Spot: Buying the asset itself, settled now. No expiry, no funding, no liquidation - and custody becomes your problem.
Futures contract: An agreement to settle the difference between an agreed price and a future price, with an expiry date. In crypto, usually cash-settled.
Perpetual swap: A futures contract with no expiry, kept near the index price by periodic funding payments between longs and shorts.
Notional: The full size of the position in money terms. Fees, funding and profit and loss are all computed on this, not on your margin.
Margin: Collateral posted against a derivatives position. Initial margin opens it; maintenance margin is the minimum that must remain.
Leverage: Notional divided by margin. A ratio describing two numbers you chose, which multiplies a price move into a margin move.
Funding rate: The periodic payment between the two sides of a perpetual, charged on notional, typically every eight hours, published before it is settled.
Liquidation: The exchange closing your position because equity fell to the maintenance requirement. Triggered by the mark price, and it is not your stop.
Basis: The difference between a futures price and the spot price. It converges to zero at expiry because the two dates become one date.

What this means in practice

Know which of the three you are trading before you look at the chart. The chart looks identical and the failure modes do not.
Compute your own notional and your own leverage ratio by division, rather than reading a label on an exchange.
Read the funding rate and work out what holding the position for your intended duration costs, in money, before you open it.
Find out where the liquidation level is, and remember it moves against you as fees and funding accrue.
Check whether your exchange triggers on mark price or last price, because your chart is showing you the latter.
Treat exchange risk as a separate question from price risk, because it is one.

Nothing in this lesson is financial advice or an instruction to trade. See the risk disclaimer. We never recommend a leverage setting - that decision is yours.