Perpetual contracts can be described as a derivative product. It’s an evolution of traditional futures contracts but quite different in some aspects since they lack a settlement or expiry date, meaning they can be traded infinitely. Futures contracts allow their holders to buy and sell assets at a predetermined price and specific date.
Unlike traditional markets, trades on futures markets don’t settle instantly but allow the involved parties to trade contracts with the specifics of how they will settle on a future date. There are a few unique features of futures contracts you need to be aware of, with one being the inability of holders to buy or sell the actual asset directly. What they are allowed to trade are contracts representing the assets with the real exchange or the cash or asset occurring when the contract is settled in the future.
To understand how a futures contract works imagine entering a contract that specified the sale of one BTC for $15,000 on September 1, 2020. Before the contract expires, it can be traded several times, and this allows speculators to buy and sell it based on what they see the price of BTC could be in the future. For this reason, the price of futures contracts can deviate drastically from that of its underlying asset on the spot market.
As financial instruments that allow users to hold leveraged positions with little worry for expiration dates, perpetual contracts have seen their popularity grow massively over the past few years. Unlike futures, these contracts trade close to their underlying asset due to perpetual funding rates.
The price stability of perpetual contracts is maintained using perpetual funding rates, which offer incentives for people to purchase contracts when the price is below the index. Once the price gets over the index, they offer traders a reason to sell.
The funding rates must be designed the right way since, if not, they can cause massive price deviations, making it challenging to maintain the price stability of the contracts. When funding rates are not well built, they increase risk, which scares away liquidity providers.
Perpetual Contracts Elements
There are a few elements that act as the backbone for perpetual contracts such as initial margin, maintenance margin, and liquidation. The initial margin is the least amount you have to pay to open a leveraged position on any platform. An example of this is when you decide to purchase 100 BTC using a 10x leverage. This means you need 10 Bitcoins as your initial margin. Always remember that this margin acts as your collateral.
To keep an open trading position, you need to have a maintenance margin, which is the least amount of collateral required. But if your margin balance sinks below this level, you will be represented with two options; you will be asked to add funds to your account through a margin call or get liquidated. Liquidation will only happen if your collateral drops below the maintenance margin. How this process occurs differs from one exchange to another, and it’s the most preferred move by the majority of exchanges offering margin trading.
Where Can You Trade Perpetual Contracts And What Are The Differences?
AAX is the first cryptocurrency exchange to be powered by LSEG technology. The platform offers deep liquidity, high security, and very low latency trading across several digital assets. On the exchange, funding takes place in eight-hour intervals where one can trade with up to 100x leverage on assets like BTC, ETH, and from August 19, also ChainLink, Compound, and Bitcoin Cash.
AAX is growing within the futures market due to its high liquidity, high volume, and fees charged with some of the lowest in the industry. Its USDT settled BTC contracts are popular, and the platform plans to add more contracts soon. On the exchange users have access to over the counter (OTC), spot and futures trading and there is also an AAB coin, the platform’s native token which gives users discount on trading.
BitMEX is a leader when it comes to perpetual contracts and one the platform one can access and trade with up to 100x leverage on contracts for BTC/USD, XRP/USD, and ETH/USD. As for the funding rate, this will happen at intervals of 8 hours. It’sAt these intervals; you can pay or receive funding as long as you hold a position during the periods. On this platform, you can go long or short on the contracts by purchasing or selling them. It’s even possible to sell if you don’t hold any contracts, which makes the platform valuable for “naked” shorting purposes. On the exchange, get the funding by multiply the funding rate by the position figure.
Earlier this year, dydX began offering BTC/USDC perpetual contacts, thereby becoming a leader among similar platforms for providing non-custodial perpetual markets. The is no central authority that has control of the funds on the platform since they are held on smart contracts. And when it comes to price information, the exchange uses MakerDAO. Besides a few unique differences, this exchange is quite similar to BitMEX when it comes to its perpetual market design.
For example, smart contracts are responsible for calculating and apply for funding after every second with rates updated every hour. The platform realizes the importance of continuous funding to keep both the perpetual and mark price in close range, thereby helping eliminate the chance of funding bias, which can quickly build up over time when different funding rate designs are used.
The world’s leading exchange by volume, Binance has a futures platform that offers perpetual contracts for BTC/USD, BCH/USD, and ETH/USD with leverage of up to 125x for BTC and 75x for the other two. The funding rate on Binance resembles that of other exchanges mentioned above, with the only difference being that no funding basis is used to calculate the premium index. The platform has a way to calculate separately at every funding window with the formula not relying on the previous rate.