Everything you need to know about the perpetual contract
In case this is the first time you land on this domain - we, at Perpetual Protocol, are building a decentralized perpetual contract protocol for every asset. If you want to start trading perpetual contracts after reading this article, please visit perp.exchange.
Don’t leave the page just yet! I promise the above is the only place we shill our service. In the following, we’ll teach you the ins and outs of perpetual contracts.
So first things first - what is a perpetual contract?
A perpetual contract is a derivative (i.e. a financial product whose price derives from another asset) that makes price speculation on an asset easy. You use a USD-pegged stablecoin, like USDT or USDC, as the collateral to open a leveraged position. If you speculate that the price of the asset will go up and it indeed goes up, you’ll receive more stablecoins in return. If the price goes in the opposite direction, you’ll receive less than the amount you put into this position.
Due to their ease of use, perpetual contracts are the most traded instrument in the cryptocurrency space, with trillions of dollars in trading volume each day.
Since a perpetual contract is a derivative, its price isn’t always the same as the underlying asset. As an example, during a bull market, the price of a BTC perpetual contract is usually higher than the price of BTC on the spot market, because people tend to be more bullish and expect the price to keep going up.
To reduce the price discrepancy between the perpetual market and the spot market, derivative exchanges in this space adopt a mechanism called “funding payments”. The way funding payments work is, there are automatic payments between traders at fixed intervals (e.g. every hour, or every 8 hours), where the traders on the more popular side (the long side during a bull market) will pay the less popular side (the short side during a bull market). By doing this, people will be incentivized to open a position with the less popular side, hence driving the price toward the spot price.
For instance, if 1 ETH perpetual contract is traded at 2,000 USD on a perpetual market (this price is known as the “mark price”) while 1 ETH on average is traded at 1,900 USD across the spot markets on multiple exchanges (this price is known as the “index price”), that means there is an excessive amount of longs on the perpetual market. To bring the two prices in line, at a fixed interval, the long holders will pay a funding payment to short holders. The greater the price discrepancy, the higher the funding rates will be, which results in a bigger funding payment. Note that funding payments are calculated by multiplying the USD value of a position by the funding rate.
Hope till this point, you understand how perpetual contracts work and how prices are kept close to that of the underlying assets. If you want to learn more about the comparison between perpetual contracts and other price speculation methods, such as just buying the asset on the spot market, please check this article.
One last thing. Before you start trading perpetual contracts, it’s crucial to understand the risks associated with using leverage. You can check this article for more on this topic.