What are Perpetual Contracts?
Perpetual contracts, also known as perpetual swaps, are a type of derivative financial instrument that are similar to futures contracts but do not have a predetermined expiration date. They allow traders to speculate on the price movements of an underlying asset, such as a cryptocurrency or commodity, without having to physically own the asset.
In a perpetual contract, traders enter into a agreement to exchange the difference in price of an underlying asset between the time they enter the contract and the time they close it. The contract is settled on a regular basis and the traders' positions are marked to market, meaning that they are revalued based on the current market price of the underlying asset. Unlike futures contracts, perpetual contracts do not have a predetermined expiration date and can be held indefinitely, as long as both parties agree to the terms of the contract.
Perpetual contracts are often used by traders who are looking to take advantage of price movements in the underlying asset, without having to physically own the asset. They allow traders to trade with leverage, meaning that they can control a larger position with a smaller amount of capital, increasing their potential profits and losses. However, this increased leverage also means that traders must be cautious and manage their risk carefully, as losses can quickly spiral out of control if the market moves against them.
One of the key features of perpetual contracts is the funding mechanism, which is designed to prevent one party from having an unfair advantage over the other. In a perpetual contract, the funding mechanism works by adjusting the price of the contract based on the interest rate differential between the long and short positions. This means that traders who are long (betting on the price of the asset to increase) must pay a funding rate to traders who are short (betting on the price of the asset to decrease), and vice versa. This helps to ensure that the price of the contract remains aligned with the underlying asset, preventing one party from having an unfair advantage over the other.
Simplified Example
Perpetual Contracts work the same way in finance. They are like a never-ending game of buying and selling, where the contracts keep going and going, with no end date. The price of the asset being traded may go up and down, but the contract itself never ends.
Just like how playing a never-ending game of tag keeps you on your toes, Perpetual Contracts keep traders on their toes, because the price of the asset can change at any time.
So, in short, Perpetual Contracts are like playing a never-ending game of tag. They are like a never-ending game of buying and selling, where the contracts keep going and going, with no end date, and the price of the asset can change at any time.
Who Invented Perpetual Contracts?
The origin of the term "perpetual contracts" presents a challenge, yet it is commonly associated with two influential figures:
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Robert Shiller: In 1992, economist Robert Shiller introduced the concept of "perpetual futures contracts" through his paper, "Speculative Prices and Stock Market Volatility." Shiller proposed a groundbreaking type of futures contract characterized by the absence of a fixed expiry date, allowing for continuous trading and speculation on underlying assets.
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BitMEX: Often credited with launching the first live perpetual contracts for cryptocurrencies in 2016, the cryptocurrency exchange BitMEX played a pivotal role. Initially referred to as "perpetual swaps," these contracts quickly gained favor for their advantages over traditional futures contracts, offering lower fees and increased leverage.
Examples
Perpetual Futures Contract in Cryptocurrency Trading: Perpetual futures contracts in cryptocurrency trading are similar to traditional futures contracts, except they do not have an expiration date. This means that a trader can hold a position in a perpetual futures contract indefinitely, as long as they have sufficient margin to cover any potential losses. Perpetual futures contracts allow traders to speculate on the price movements of cryptocurrencies such as Bitcoin, Ethereum, and others without having to worry about the expiration of their positions. To trade perpetual futures contracts, a trader would deposit collateral, such as Bitcoin, into a margin account. They can then use this collateral to buy or sell futures contracts, with the value of their positions determined by the underlying cryptocurrency price.
Perpetual Swaps in Foreign Exchange Trading: Perpetual swaps in foreign exchange trading are similar to perpetual futures contracts in cryptocurrency trading, with the key difference being that they are used to trade currencies, rather than cryptocurrencies. A trader can use a perpetual swap to speculate on the price movements of currencies such as the US dollar, Euro, or Japanese yen, without having to worry about the expiration of their position. To trade perpetual swaps, a trader would deposit collateral, such as US dollars, into a margin account. They can then use this collateral to buy or sell currency pairs, with the value of their positions determined by the underlying currency exchange rate.
Perpetual Options in Stock Trading: Perpetual options in stock trading are a type of option contract that does not have an expiration date. This means that a trader can hold a position in a perpetual option indefinitely, as long as they have sufficient margin to cover any potential losses. Perpetual options allow traders to speculate on the price movements of stocks and other securities without having to worry about the expiration of their positions. To trade perpetual options, a trader would deposit collateral, such as cash or stocks, into a margin account. They can then use this collateral to buy or sell options contracts, with the value of their positions determined by the underlying stock price.