Spot vs. perpetual futures: funding, margin, and liquidation

Spot is simple

Spot trading means you buy the coin and you own the coin. You pay $100 of USDC, you get $100 of BTC. If BTC doubles, you have $200. If it halves, you have $50. You can never lose more than you put in. You cannot easily bet on price going down. That is spot. There is not much more to say about it.

A perpetual future is a contract

A perpetual future, a perp, is not the coin. It is a contract whose price tracks the coin. You never own BTC. You own a position whose profit and loss moves with BTC.

Why would anyone want that? Three reasons. You can short as easily as you can go long. You can use leverage. And you never have to take delivery of anything. A traditional future expires on a date. A perp never expires. That is what perpetual means.

But this creates a problem. If the contract never expires, nothing forces its price to match the spot price. The exchanges solved this with funding.

Funding is the anchor

Every funding interval, usually every one to eight hours, money moves between longs and shorts. If the perp trades above spot, longs pay shorts. If it trades below spot, shorts pay longs. The payment pushes traders toward the cheap side, and that pushes the perp price back toward spot.

Understand what this means for you. Funding is not a fee the exchange charges. It is a payment between traders, and you are one of the traders. When everyone is long and bullish, longs pay. Holding a long in a euphoric market costs money every few hours, around the clock, whether the price moves or not.

Traders ask whether funding matters. Here is the arithmetic. Funding of 0.01 percent per 8 hours sounds like nothing. It is roughly 11 percent per year. In hot markets funding runs far higher. A strategy that holds long positions through a bull market can give back a large share of its edge in funding alone. A backtest that ignores funding does not know this. See realistic backtesting.

Funding also flips. Last year's strategy collected funding. This year the same strategy pays it. The rules did not change. The crowd changed sides.

Margin and leverage

To open a perp position you post margin. Margin is collateral. With $1,000 of margin and 5x leverage, you control a $5,000 position.

Leverage multiplies everything. A 2 percent move in your favor is a 10 percent gain on your margin. A 2 percent move against you is a 10 percent loss. The market did the same thing in both cases. Your size decided how much it hurt.

Beginners believe leverage increases their edge. It does not. Your edge is your edge. Leverage only increases the speed at which the market delivers the verdict. If your trader's equation is negative, leverage helps you find out faster, with less money left at the end. See the trader's equation.

Liquidation is the floor

Here is the part that ends accounts. If the market moves against a leveraged position far enough, your margin no longer covers the potential loss. The exchange closes your position by force. That is liquidation.

Liquidation is not like a drawdown. A drawdown can recover. A liquidation cannot. The position is gone, the margin is gone, and the move you were waiting for can now happen without you.

The arithmetic is unforgiving. At 10x leverage, a move of roughly 10 percent against you wipes the position. BTC moves 10 percent in a bad week. Altcoins do it in a bad afternoon. High leverage on a volatile asset is not a strategy. It is a countdown.

There is a second-order effect worth knowing. When price falls, leveraged longs get liquidated. Their forced selling pushes price lower, which liquidates more longs. This is a liquidation cascade. It is why crypto crashes are fast and deep, and why your stop will sometimes fill far below its level. The cascade does not care about your backtest.

What this means for your strategies

If your strategy holds perp positions, funding is part of your trader's equation. Count it.

Leverage does not improve a strategy. It scales the outcome of a strategy. Scale only what already works.

Size every position so that the worst realistic move cannot liquidate you. Not the average move. The worst one. See risk.

Backtest with funding and liquidation mechanics on. A backtest without them is a story.

How Edgecraft handles this

Edgecraft backtests apply historical funding rates bar by bar, so a strategy that bleeds funding shows the bleed in testing instead of in your account. Position sizing and risk checks treat liquidation as a hard boundary, not a bad day. The drawdown you see in the results already includes the cost of holding the contract, not just the movement of the price.