Perpetual Futures Contracts Explained
Perpetual Contracts are the advanced derivative of conventional futures contracts, whereas it doesn’t have any specific expiry date so that the buyer or seller can hold their assets/position as long as they choose. In other words, one can buy the contract when the asset price will be subjected to rise in the future and conversely can sell the contract when the asset price is subjected to slump in the future.
Trading with bitcoin or any other cryptocurrencies has become viral among people in the last few years. At first, when bitcoin was introduced, there were only a few people willing to adopt it and use it. But, after the huge price hike in 2017 many traders have taken an immediate turn towards cryptocurrencies especially “bitcoin”. This resulted in a huge growth of “Bitcoin adoption” all around the world and bitcoin trading ratio have been increased tremendously everywhere. To make the industry stable and to maintain the sudden hike under a line, many popular bitcoin exchanges like bitfinex, bitstamp, poloniex have been started to encourage bitcoin traders by introducing new kinds of trading features in their exchange platform and it was an indirect purpose of making the traders stick with their business.
Most notably leverage trading followed by margin trading were the most significant trading derivatives, which were brought up a lot of new bitcoin traders inside the cryptocurrency industry. Because of this, the base of the cryptocurrency industry has become stronger, and the industry has started to grow in various branches, like tokens, ICO, STO, Dapps and more.
Before few years, people were hesitant to trade with bitcoin as it has high volatility in price, and new traders didn’t have that much fund to trade with bitcoin. So, the freedom of bitcoin trading was under a limited bound, and there comes a situation of only pro traders alone to befall in bitcoin trading, often. But, the advent of margin trading(Leverage Trading) and margin trading with lending, concepts have encouraged the traders to trade bitcoins, even if they don’t have enough funds.
Before Perpetual Contracts
To understand the concept of Perpetual Futures Contracts in detail, it is a must for us to recap the previous cryptocurrency derivative “Margin Trading”.
Margin Trading (Leverage Trading)
Margin Trading can also be referred to as Leverage trading as it follows the same methodologies. The term “leverage” alone explains the concept. That is leveraging( Lifting up) a trader's position to an eligibility level of trading more bitcoins with the funds he/she have. Here a margin amount will be deposited to the traders are margin account, and the trader has to provide collateral for the provided margin amount at a certain level of ratio (This ration differs based on the exchange ). When the traders meet the eligibility level, he/she can trade with the provided margin amount, and the profit or loss will impact the traders funding account. After closing the trade, the trader has to return the provided margin amount with interest.
This trading concept was viral during the mid of 2017, and it is still popular among traders as well as exchanges.
We have discussed the concept in our earlier articles.
Advantages of Margin Trading
- Results in larger profits
- A trader can open several leverage position with small amount of investments as initial margin
- Having a margin account can help the traders to open trading/ leverage position quickly.
- Instant High benefits always Have High Risks.
- Even a small drop in the market cap of the underlying asset can cause a huge loss.
- When traders choose a long position ( that is buying value ) but the price decreases suddenly they could get a margin call, to deposit more funds in a margin account to meet the minimum margin trading requirements.
We can mitigate these kinds of risks by using proper risk management strategies and risk management options like stop-limit orders.
Reference : Margin Trading
Introduction To Perpetual Futures Contracts
“Perpetual future contracts” is the recent trading feature of many cryptocurrency exchanges and becomes popular among cryptocurrency traders. Understanding the concept of Perpetual Contracts (or)Perpetual trading will become easy if we can understand the concept of conventional futures contracts.
Source : Binance vision
What are Futures Contracts?
A futures contract is a mutual digital agreement between the buyer or seller to buy/ sell an asset, commodity, currency or any other instrument at a predetermined fixed price at a specific date or time in the future.
To convey simply, one can buy an asset from the seller at a predetermined price by not considering the current market price of the asset at a predetermined specific time in the future.
How Does It work?
As said in the above video, let us consider the Alice and bob scenario for example.
Alice ( The Buyer ) and Bob ( The Seller) create a contract between them to trade a bitcoin at a price of $10000 by the end of the year, exactly on December 31st. So, here bob must sell a bitcoin to Alice exactly at a price of $10000.
For instance, if the bitcoin price surged to $12,000 on December 31st, then Alice could save a huge amount of money and can get a profit of $2000 from the trade. Comparatively, if the same bitcoin price has slumped to $9000, then Alice has to pay the same price declared in the contract that is $10000, and the bob can get a profit of $1000 from the trade. There will be 50 - 50 possibility of Profit or loss on both sides, hence we call this as a mutual contract. The loss & risk always of the contracts always depend on the market price of the underlying asset.
Futures market won’t allow the users to trade assets directly, instead, they just represent the contract representation of the commodity or assets. When the contract time expires then the direct trading of assets(cash) between the two parties will be exercised. This is known as “cash Settlement”. Most of the futures contracts, or made to be traded on the real-life physical assets like gold, wheat or oil, and they are marked for delivery. But, it is impossible to store all the assets at storage on each trade, as it will cost high. So, currently, future markets execute the contracts by representing the equivalent cash value of the goods or commodities to be exchanged directly.
Just like the margin trading, If a trader wants to enter into a futures contract, then he/she could meet some minimum requirements to choose the leverage ratio. Recently binance has extended its leverage ratio on binance futures to let the traders choose up to 125x Leverage, Previously it was 20X.
What does the terms 125x, leverage ratio, long position, short position and so on.. means for?
It is the buying position of a trader, it represents an assumption that the price of an asset will go up.
It is the selling position of a trader, it represents an assumption that the price of an asset will go down.
It is the trading ratio, that could be chosen from the trader end to open a buy(long) or sell (short) position to initiate the trade. This ratio will be ranged from 2:1 to 100:1 or more than that, and the crypto trading community prefers X terminology to represent the ratio.
For example, let us assume the chosen leverage is 20X then the ratio will be considered as 20:1. So, in this case, you have 100USDT, and if you choose a 10:1 ratio then the largest long (buy) position you can make to trade is 0.2 BTC.
Whereas the 100USDT will be considered as the Collateral, and when the trading opens it will be referred to as the “Initial Margin”.
Perpetual Futures Contracts
Perpetual which means - Never Ending, so there is no expiry date.
As Said above,
Perpetual Contracts are the advanced derivative of conventional futures contracts, whereas it doesn’t have any specific expiry date so that the buyer or seller can hold their assets/position as long as they choose. In other words, one can buy the contract when the price will be subjected to rise in the future and conversely can sell the contract if the price is subjected to slump in the future.
Difference Between Futures and Perpetual Contracts
- Perpetual Future Contracts and Traditional Futures Contracts likely to be the same, but the only and the major difference is, Perpetual Contracts Doesn't Have any Expiry Dates.
- And another significant difference is, perpetual contract receives funding fees, but in the futures contract, it won’t do it.
Since a perpetual contract doesn’t have an expiry, it is likely to be considered as Spot- Trading but, with leverage. So, that we can trade nearly at the price of the current market value of the indexed asset, commodity, or crypto.
Characteristic of Perpetual Contracts
- No Expiry Date
- Mark Price
- Dual Price Mechanism
- Initial Margin & Maintenance Margin
- Increased Leverage Ratio From 10X to 100 x or more
- Auto Deleveraging
Mechanics Of Perpetual Futures Contracts
Initial Margin is the minimum payable amount to open leverage positions, For example, if you choose 100:1 leverage to trade 10000USDT then you should pay 100USDT as the initial margin, Whereas the initial margin acts as the collateral of the contracts.
The maintenance margin is the minimum balance amount that you must hold in your margin account to keep your trading positions open. Maintenance margin changes based on the market price of the underlying asset. If the Market value faces a huge slope then your assets will be liquidated, so that all your current trading positions will be closed. To prevent the account from being liquidated, you would receive a “ Margin Call”, and it will ask you to deposit more money into your account to keep all the trading positions open.
If the maintenance margin drops below the minimum value, then your futures account will come under “Liquidation”. This liquidation limit differs based on an exchange, and the leverage ratio the trader chooses. The additional point here, whenever an account is subjected to be liquidated, then the trader should pay a fee for that. That will also be debited from the futures account. If any funds remind in the future account after liquidation it will be returned to the user, and if the trader has no value, and he is mean to pay money, then it will be declared as “bankrupt”.
It is the payment between buyers and sellers. Funding rate defines who is the payer and payee. If the funding rate is above zero, then it will be a positive funding rate, so that the longers( Contract Buyers) should pay the shorts ( Contract Sellers). If the funding rate is negative then the shorts have to pay the longs.
If the futures contract is traded on the premium (above the market price), then the long positions have to pay the shorts. If there exists a situation, longs may close their account, and shorts may open new accounts, this may cause a huge price down.
It is the estimated price value of the contract, by comparing it with the current trading price. This mark price calculation prevents a futures account from being liquidated while there is huge volatility occurs on the market. Also, mark price plays a huge role in calculating the “ “unrealized PnL”.
Some exchanges like binance having insurance fund features in perpetual future contracts.
Insurance funds safeguard a trader's futures account from bankrupt when there occurs a liquidation. During the liquidation, the trader can pay with insurance funds, if he/she doesn’t have enough amount on balance, and hence the trader can prevent the account balance to be fall under “0”.
Profit and Loss. There are Two PnL’s.
- Realized PnL
- Unrealized PnL
Check out PnL Calculation provided by BitForex Exchange as an example to understand realized and unrealized PnL calculations.
Auto De-Leveraging ( Contract Loss Mechanisms)
It is the counterparty liquidation methodology. That can be employed when the insurance fund is not enough to meet the liquidation payables. If this exists in the traditional trading market, there becomes a situation, whereas the profitable traders can contribute to preventing the traders who are losing But, in the cryptocurrency market it will not be recommendable, since there exists huge volatility, and moreover no trader will be willing to contribute themselves.
So, soulfully it is a contract prevention mechanism, that can help the traders from huge losses caused by unfair traders.
Exchanges that Supports Perpetual Futures Contracts
Perpetual Future Contracts are the most profitable trading instrument of the cryptocurrency trading market. By deploying advanced trading tools recommended by any exchanges, and by following unique strategies, one can prevent the futures account to fall under risk.
Our Cryptocurrency Exchange Script Supports Perpetual Trading
We bitdeal, a top-rated cryptocurrency exchange development company, have practiced the development of a perpetual contract trading feature and integrating it into our primary exchange script. So now you can get cryptocurrency exchange script with perpetual trading feature and additional trading features offered by the popular crypto exchanges.Perpetual Futures Contracts
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