Two terms you may come across in crypto trading: contract for difference (CFDs) and perpetual swaps. But what are they and should you be trading them?
Let’s start with the basics:
CFDs and perpetual swaps are types of derivative that can be traded. They’re contracts that derive value from particular assets, like Bitcoin, for example. CFDs and perpetual swaps are popular with crypto traders because they allow for speculation on price action without having to own the underlying asset.
What are CFDs?
When you open a CFD position, you are taking a “contract for difference” with the exchange on a certain asset. At the end of the contract, the difference between the open price and current price determines if you’ve made a profit or not.
The duration of the contract depends on the issuer. Some contracts expire within 30 days, meaning traders have to close their positions after that time. Other contracts are perpetual, meaning they never expire and can be closed any time. CFDs on Liquid have no expiry.
What are perpetual swaps?
Perpetual swaps are another type of derivative trading, essentially, a futures contract with no expiry date.
When traders have a perpetual swap trade open, they may have to pay funding fees. A mechanism ensures convergence of the perpetual price to the true price by exchange of currency swaps between long and short users.
So if the perpetual price is greater than the spot market price, longs have to pay the shorts a funding fee. If the perpetual price is less than the spot price, shorts have to pay longs. This incentivizes traders to open certain positions, thus ensuring the perpetual price stays close to the market price.
There are two directions that can be taken to trade CFDs and perpetual swaps:
- If a trader thinks the price of an asset is going to increase, then they are able to open a long position.
- Alternatively, if a trader thinks the price of an asset is going to decrease, they can open a short position.
How it works
When a trader opens a derivative position, the difference between the open price and closing price will be used to calculate profit, taking into account both trading direction and position size.
Here’s an example:
A trader opens a long position on Bitcoin. The open price was 11,000 USD and position size was 2 BTC.
If the price of Bitcoin then increases to 12,500 USD, the difference is 1,500 USD. Profit is 1,500 x 2 = 3,000 USD. Nicely done.
But if the price of Bitcoin falls to 10,500 USD, the difference would be 500 USD. With a long open, the loss is 500 x 2 = 1,000 USD. Better luck next time.
On top of profit and loss there are other fees and charges to be aware of, such as initial and closing trade fee and interest or financing fees.
Why trade derivatives?
Trade can increase the size of their trades by using leverage. Liquid customers can trade with up to 100x leverage on Bitcoin CFDs.
The trader does not have to ever own the underlying asset to speculate on price movements.
Make profit when prices go down, all without owning the asset.
Fees over interest
On Liquid, Bitcoin CFDs have funding fees rather than interest, which is preferable for many traders.