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Perpetual Contracts

Give me the basics

Perpetual contracts are a type of futures contract that do not have an expiration date, allowing traders to hold positions indefinitely. In the context of cryptocurrencies, perpetual contracts are a popular derivative product offered by exchanges such as BitMEX and Binance, allowing traders to speculate on the price movements of cryptocurrencies without actually owning them. Perpetual contracts typically use a funding rate to ensure that the price of the contract remains close to the underlying asset’s spot price, and can be settled either in cash or the underlying asset.

In-depth explanation

Futures contracts have been a popular financial instrument for centuries, allowing traders to speculate on the future price of a commodity or asset. However, in the world of cryptocurrencies, a new type of futures contract has emerged: the perpetual contract.

A perpetual contract is a type of futures contract that does not have an expiration date, allowing traders to hold positions indefinitely. In the context of cryptocurrencies, perpetual contracts are a popular derivative product offered by exchanges such as BitMEX and Binance, allowing traders to speculate on the price movements of cryptocurrencies without actually owning them.

One of the key advantages of perpetual contracts is their flexibility. Unlike traditional futures contracts, which have a set expiration date and require traders to roll over their positions, perpetual contracts can be held indefinitely. This means that traders can maintain their positions for as long as they want, without having to worry about the contract expiring or rolling over.

Another advantage of perpetual contracts is their ability to offer leverage. Because traders do not have to put up the full value of the contract, they can use leverage to amplify their potential profits (and losses). For example, a trader who puts up $1,000 in margin for a 10x leveraged perpetual contract could potentially earn (or lose) as much as $10,000 in profit (or loss) if the price of the underlying asset moves in their favor (or against them).

However, there are also some potential drawbacks to perpetual contracts. One of the main criticisms is that they can be more complex and risky than traditional futures contracts. Because they do not have an expiration date, traders must monitor their positions carefully to avoid potential losses. Additionally, because perpetual contracts use leverage, traders can be exposed to significant losses if the market moves against them.

To mitigate these risks, most perpetual contracts use a funding rate to ensure that the price of the contract remains close to the underlying asset’s spot price. This funding rate is periodically paid by traders who are long the contract to traders who are short the contract, and is used to incentivize traders to maintain positions that reflect the market’s expectations.

Perpetual contracts can also be settled in different ways. Some exchanges settle perpetual contracts in cash, meaning that traders do not actually receive the underlying asset when the contract is settled. Others settle in the underlying asset itself, meaning that traders must have the assets in their account to settle the contract.

Despite these potential challenges, perpetual contracts have become a popular tool for traders looking to speculate on the price movements of cryptocurrencies. Their flexibility and leverage make them an attractive option for those looking to amplify their potential profits (and losses), while the use of funding rates helps to ensure that the price of the contract remains close to the spot price of the underlying asset. As the cryptocurrency market continues to evolve and mature, it will be interesting to see how perpetual contracts continue to play a role in shaping the future of digital asset trading.