A Perpetual Contract is similar to a traditional Futures Contract, but 2 key difference between two products is
A Traditional Future allows a trader to buy or sell a physical commodity, like gold, as an example. In other words, futures contracts have a limited lifespan and will expire based on their respective calendar cycle. As such, someone is physically holding the gold, which results in ‘carrying costs’ for the contract. Additionally, the price for gold may differ depending on how far apart the current time and the future settlement time for the contract is. As this gap widens, the contract’s carrying costs increase, the potential future price becomes more uncertain, and the potential price gap between the Spot and traditional Futures markets grows larger.
The Perpetual Contract is an attempt to take advantage of a Futures Contract - specifically, the non-delivery of the actual commodity - while mimicking the behavior of the Spot market in order to reduce the price gap between the Futures Price and the Mark Price. This is a marked improvement compared to the traditional Futures Contract, which can have prolonged or even permanent differences versus the Spot Price.
Since perpetual futures contracts never settle in the traditional sense, exchanges need a mechanism to ensure that futures prices and index prices converge on a regular basis. This mechanism is also known as Funding Rate/Fees.
Funding fees are periodic payments either to traders that are 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.
Unlike Perpetual Future, Traditional Future do not carry a funding fee. This is favorable to long-term position traders and hedgers as funding fees may fluctuate over time. Especially in extreme market conditions, high funding fees can be costly to maintain a long-term position in the market.
Assuming that funding fees across BTC perpetual markets may surge as Bitcoin prices rally, this indicates the imbalance of buying pressure in the market. As such, this effect results in long positions becoming more costly to hold over time.
Several key concepts that traders should be aware of in a Perpetual Contract
To avoid market manipulations and to ensure that the Perpetual Contract is price-matched to the Spot Price, we utilize Mark Price to calculate unrealized Profit and Loss for all traders.
Initial Margin and Maintenance Margin
Traders should be extremely familiar with both Initial and Maintenance Margin levels, in particular, the Maintenance Margin, where auto-liquidation will occur. It is strongly recommended that traders liquidate their positions above the Maintenance Margin to avoid higher fees from auto-liquidations.
Payments between all longs and shorts in the Perpetual Futures Market. The Funding Rate determines which party is the payer and the payee. If the rate is positive, longs pay short; If negative, shorts pay longs.
Unlike Spot Markets, Futures Markets allow traders to place large orders that are not fully covered by their initial collateral. This is known as ‘margin trading.’ As markets have become more technologically advanced, the amount of available margin has increased.