What Are Perpetual Contracts?

July 30, 2022

Bitcoin

What Are Perpetual Contracts?

Cryptocurrency has evolved over the years, and every year, there is usually a new trend in the crypto space, such that it becomes hard to track all that is happening in the industry. From simple spot trading, crypto has evolved into derivatives trading. There are NFTs (Non-fungible tokens), dApps, DeFi (decentralized finance), and others.

One concept that users might find difficult to understand is perpetual contracts. Crypto users often mistake futures contracts for perpetual contracts and thus misinterpret the real meaning of perpetual contracts.

This article will provide a clear definition of perpetual contracts and the key details you need to know about them. Understanding the true meaning of perpetual contracts would help you take full advantage of the opportunities it offers users in the crypto space.

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What is a Futures Contract?

Perpetual Contracts are a type of futures contract with some unique features. Thus, we need to study what futures contracts entail to understand perpetual contracts. A futures contract refers to an agreement where a user determines to sell or buy a commodity, asset, currency, or any other financial instrument at a predetermined price are a specific period in the future. As the name denotes, there is a contract that a certain asset is bought or sold at a specific price in the future. Here, all details are set, including the price and the time the transaction is to occur in the future. Also, traders do not trade the asset instantly but simply trade a contract that represents the asset, and the actual trade would occur in the future when the contract is activated.

There are a few reasons why traders use futures contracts. First, it gives them more leverage, such that they can open trade positions larger than their crypto trading accounts and earn more profits if the trade goes as predicted. Also, future contracts allow risk management and hedging, which is essential to the creation of futures contracts. In addition, futures give traders short exposure in that they can trade an asset even if they do not own such an asset. It limits the possibility of loss.

Are Perpetual Contracts Real?

Yes, perpetual contracts are very much real. They are a type of regular futures contract. They are so real that they have properties that make them stand out from other contracts. But in simple terms, perpetual contracts refer to an understanding between the user and the exchange to sell or purchase a certain amount of assets at a time in the future at a pre-set price. This means that today, you get the price at which you want to buy the asset, but the actual trade doesn’t take place till later. It is a futuristic agreement with a predetermined price.

Also, unlike others, perpetual contracts come with no expiration date. This means that users can place future trades via these contracts and hold such position until they decide to close it or until they are liquidated from the market.

Furthermore, the basis of perpetual contracts is the use of index price with the average price of coins, tokens, or digital assets. This price ensures that the price level of the contract is closely related to that of the spot markets, by creating it (the price of contracts) based on information on top spots and the trading volumes applicable in these markets. However, we may find a large disparity between the spot market price and the perpetual contracts, often due to severe or drastic market conditions on rare occasions.

Key Features of Perpetual Contracts

Now that you understand what perpetual contracts entail, here is a highlighted list of the key features of these contracts.

Future trade: The aim is not to earn profits immediately, which isn’t possible because trade does not open immediately. But rather, users place contracts that are meant to create a trade in the future with a predetermined price level.
Index Price: unlike other contracts, perpetual contracts allow users to get a price that is close to what is currently available in the spot market. This is only possible for the index price of such contracts, which are created considering the trading volume of spot markets.
No Expiration Date: traders like to use perpetual contracts because it comes with no expiration date. The agreement to open a position on a future date doesn’t end until you close the trade or get liquidated. So, while the absence of an expiry date is great, it also tends to lead to negligence of trade, such that you do not monitor your trade and get liquidated when the market rapidly moves against you. Always ensure to monitor your perpetual contracts regardless of there not being an expiry date.

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