A Perpetual Contract is similar to a traditional Futures Contract, but the key difference is: There is no expiration or settlement of Perpetual Contracts.
Consider a Futures Contract for a physical commodity, like wheat (or gold), as an example. In traditional futures markets, these contracts are marked for delivery of the wheat - in other words, the wheat should be delivered according to the contract when the futures contract expires. As such, someone is physically holding the wheat, which results in ‘carrying costs’ for the contract. Additionally, the price for wheat 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.
In order to ensure long-term convergence between the Perpetual Contract and the Mark Price, we use Funding. There are several key concepts that traders should be aware of in a Perpetual Contract:
- Mark Price: 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 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.
- Funding: 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.
- Risk: 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.