Article 1: Structure and Core Mechanics
David Todd, Chief of Staff at One Trading
Introduction
Perpetual futures dominate global crypto trading volumes. Access to “leverage”, which allows traders to hold positions larger than their available collateral, means that across major exchanges, the volume of trading in perpetual futures markets is often many times higher than in the equivalent spot markets.
Perpetual futures are derivatives, which means they are regulated financial products on onshore venues. Regulated exchanges typically require traders to pass an appropriateness test that includes questions on risk tolerance and product knowledge before trading. Passing this test demonstrates a baseline level of understanding.
Once a trader has demonstrated sufficient knowledge, the product becomes available to trade, often with significant leverage. However, becoming an expert in the mechanics that drive perpetual futures markets - leverage dynamics, funding rates, maintenance margin, liquidation processes, and more – involves a greater level of understanding than the baseline level of knowledge required to trade. A knowledge gap therefore exists between knowing enough to trade, and knowing enough to truly understand market behaviour.
It is in this gap that many persistent myths originate. Liquidation cascades, funding-rate-driven price moves, and liquidity withdrawal during volatility are often described as “market manipulation” or “unfair behaviour” when, in reality, these outcomes are generally structural, somewhat predictable, and the result of risk controls interacting at market scale.
Perpetual futures do not behave like spot markets, and they are not simple products. Understanding how they work, rather than how many traders think they work, is essential for managing risk and avoiding costly misunderstandings.
What perpetual futures are
Perpetual futures, as derivatives, enable traders to gain leveraged exposure to the price movements of an underlying asset without ever actually owning the asset itself.
On a spot market (e.g. BTC/USD), when a trader buys Bitcoin with USD, they take ownership of the Bitcoin as the underlying asset. With perpetual futures, if a trader buys a Bitcoin perpetual futures contract, they never actually own Bitcoin. Instead, they hold a leveraged position where the profit and loss of the position is linked to the price of Bitcoin. They are trading exposure to the price, not the asset itself.
Every perpetual futures contract has two sides. One side is held by a trader who believes the price of the underlying asset will rise (long), while the other side is held by a trader who believes the price will fall (short).
Derivatives offer several advantages over spot:
Access to leverage — price movements are amplified both up and down relative to the amount of collateral used
The ability to speculate on both price increases and decreases — traders can go “long” or “short”, unlike spot markets where profits generally depend on price appreciation
Broader institutional participation — organisations unwilling or unable to hold spot crypto may still be comfortable holding derivative exposure, increasing overall market activity
In addition to these general characteristics of derivatives, perpetual futures have a couple of specific features that distinguish them from other derivative products such as dated futures:
No expiry date and can be held indefinitely
Cash-settled, meaning there is no delivery of the underlying asset
Together, these features make perpetual futures uniquely flexible financial instruments. They allow traders to take leveraged positions in either direction (long or short), without owning or settling in the underlying asset, and without needing to manage contract expiry dates.
Why a funding rate is needed
The price of a perpetual future is not anchored to the underlying spot price, it is free-floating. Because of this, a mechanism is needed to keep the two prices aligned, as without one, perpetual futures could trade persistently above or below the price of the spot market.
To address this, a price-alignment mechanism known as the funding rate is used. The funding rate is not a fee charged by the exchange, instead, it is a periodic transfer of value between long and short position holders, designed to encourage the market to move the price of the perpetual future back toward the underlying spot price.
The funding rate is exchanged at regular intervals, generally every four to eight hours, between the two sides of the contract. When the perpetual future is trading above the spot price, the funding rate is positive and longs pay shorts. When the perpetual future is trading below the spot price, the funding rate is negative and shorts pay longs.
These payments are typically small — often less than 0.1% per interval — but even small payments can become meaningful over time.
Most exchanges publicly display both the current funding rate and a countdown to the next funding payment. This transparency is deliberate. By clearly showing who will pay and who will receive funding, exchanges encourage traders to take the side that benefits from the payment at the end of the cycle. This incentive-driven rebalancing increases participation on the underrepresented side of the market and helps keep the price of perpetual futures aligned with the underlying spot price.
Margin, Leverage, and Liquidation
To open a perpetual futures position, a trader must allocate capital known as initial margin to fund the opening of the position. The size of the position that can be opened is determined by the relationship between the initial margin and the leverage:
Position Size = Initial Margin × Leverage
For example, to open a $1,000 position at 10x leverage, the initial margin required is $100. To open a $2,500 position at 5x leverage, the initial margin required is $500.
While initial margin determines how large a position can be opened, maintenance margin determines whether a position can remain open. Maintenance margin is the minimum amount of equity required to keep a position active.
As the market moves against a position (for example, if the price falls while holding a long position), the equity in that position decreases. Once the equity falls below the maintenance margin threshold, the position is liquidated automatically. This process is designed to occur before the account balance reaches zero.
Liquidation is not a punishment, it is a risk-management mechanism. By enforcing liquidation before the account balance reaches zero, exchanges reduce the risk of negative balances and protect both the platform and wider market during periods of volatility.
The interaction between leverage, margin, and liquidation is central to how perpetual futures markets behave.
Conclusion
Perpetual futures are powerful trading tools. They allow traders to express market views with capital efficiency, access liquidity, and hedge risk in ways that are not possible in spot markets. That flexibility, however, comes with complexity.
Leverage, funding rate, margin, and liquidation mechanics interact continuously, and small misunderstandings can compound quickly. A solid understanding of how perpetual futures are structured, and why they behave the way they do, is necessary to manage risk effectively.
In the next article, we will look at how these mechanics interact at market scale, and how they shape liquidity, volatility, and price dynamics.
