What is Spot and Perp trading?

In the cryptocurrency world, many people speculate on various financial products to earn profits. This can be achieved through two main types of trading: Spot trading and Perp trading.

Spot trading involves buying and selling assets to take advantage of their price changes, which means that when you take a spot position, you are actually buying and owning the asset. However, some traders wish to take more exposure with their available liquidity and also have instruments that allow them to build more advanced trading strategies such as hedging. This is where Perp trading comes in, introducing three innovative characteristics.

Synthetic Instruments

To understand perpetual trading, it is helpful to start with the concept of derivatives. Derivatives are financial contracts between two or more parties that derive their value from an underlying asset, such as stocks, commodities, or cryptocurrencies. This means that the value of the contract varies based on the fluctuation of the underlying asset value. Therefore, they are synthetic instruments that do not involve the exchange and physical or digital ownership of the underlying asset. They allow traders to have exposure to an asset without holding it.

Leveraged Instrument

Unlike spot trading, Perp trading allows traders to take leverage on their position, meaning that traders can control a larger position with a smaller amount of capital. This is achieved by borrowing money from liquidity providers to increase the size of their position.

For example, if you have $1,000 and want to buy a $10,000 futures contract on ETH, you can use leverage to control a position worth $10,000 with just $1,000 of your own money. With leverage, if the market goes up by 10%, you can make a net profit of $1,000 (instead of $100 without leverage). But if the market goes down by 10%, you would lose $1,000, which is your entire investment (phenomenon know as liquidation).

No Expiration Date

Perpetual contracts, unlike futures contracts or options, do not have an expiration or settlement date. This means that traders can hold them indefinitely as long as they maintain the required margin. This is the key difference between perps vs futures/options.

These three characteristics (synthetic, leverage, and perpetual) make Perp trading a highly sought-after and widely used financial instrument in crypto. It allows traders to amplify their position, bet on the downside of an asset, and implement hedging strategies.