Perpetual Futures
A guide to understanding Perpetual futures; the most popular derivative product in crypto.
What are perpetual futures?
Perpetual futures are one of the most popular trading products in the cryptocurrency space. Initially offered by popular centralised exchanges like Binance, Bitmex and Bybit. In contrast to standard futures contracts, perpetual futures don't expire and they don’t have a settlement date, hence they can be held and traded for an indefinite amount of time. Not having a settlement date can be quite beneficial to the traders, as they don't have to deal with multiple contracts with different settlement dates. Perpetuals are characterised by the availability of high leverage, sometimes over 100 times the margin. To make sure the price of the perpetual contract does not diverge too much from the price of the underlying asset , perpetual contracts use a funding rate.
What is the funding rate?
Funding Fates are periodic payments to traders that are either long or short based on the difference between perpetual contract markets and spot prices. Therefore, depending on open positions, traders will either pay or receive funding. In general when prices are trading above the price of its underlying asset, the funding rate become positive and longs pay the shorts. The opposite holds when the price of the perpetual contract is below the spot price, in this case shorts pay longs. This allows the price of the perpetual contract to for a specific asset to converge with the price of its underlying. Along with the funding rate, speculators , arbitrageurs also help with making sure the prices between the derivatives contract and the underlying do not diverge too much.
Margin Requirements-
The Margin requirements in perpetual contracts are similar to the normal future contracts traded in the traditional markets. There are two margin requirements for perpetual contracts.
Initial margin- Initial margin is the minimum amount required to pay to open a leveraged position.
Maintenance margin- Maintenance margin is the minimum balance required to be held in the margin account, in order to keep trading open. The value of Maintenance margin changes according to the market price of the collateral. It is necessary to keep the minimum balance in the margin account in order to stop your account from being liquidated.
Liquidation- Liquidation happens when your crypto futures account value drops below the maintenance margin requirement. The exchange can incur a nominal fee from the trader at the point of liquidation, which is deducted from his margin account.
Mark Price in Perpetual Futures Contracts- Mark Price is defined as the estimated true value of the contract comparable to the current trading price. In the highly volatile crypto market, mark price helps in prevention of future liquidations.
Insurance Funds- Insurance Funds help a trader secure his perpetual futures account from being liquidated. It is a simple method to safeguard a trader’s account and his collateral. The Insurance Fund is a method that uses the collateral deposited by the liquidated traders to overcome losses of bankrupt accounts. Interestingly, this fund keeps increasing when users are liquidated before the trading positions are closed. Since these positions remain open, the Insurance funds are utilized to cover the losses that were incurred due to open positions.
Most popular exchanges offering perpetual futures contracts-
Centralised exchanges-
1- Binance
2- Bybit
3- Bitmex
4- Kraken
5- OKX
6- Kucoin
DEX
1- Perpetual protocol
2- DYDX
3- Synthetix (SNX)
4- GMX (GMX)
5- Gains Network (GNS)
6- Drift
7- Derivadex
Final thoughts- With popular Centralised exchanges like FTX completely blowing up, it has become clear that the future of exchanges is Decentralised. With trust levels at an all time low for CEX’s this proves to be a perfect opportunity for DEX’s to garner market share, going forward we can see a steady trend emerging where most of the trading activity will be moved from Centralised to Decentralised exchanges. An opportune moment for the Defi Derivatives space. In our next article I will be covering one of the most popular perpetual futures exchange the perpetual protocol $PERP.