The perpetual swap contract, better known as its abbreviation "perp", is the most popular and actively traded derivatives contract in crypto. A lot of people trade it because it's a fairly straight forward financial instrument, but most don't understand all the details of it. In this post I'll explain exactly what it is, what types of perps there are and what the differences are.
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Let's start with a tiny bit of history. Bitmex created the very first perpetual swap contract in crypto in 2015. They gave it the ticker "XBT/USD" and it was an inverse, coin margin perp. It was a beautiful invention that quickly gained a lot of traction and would inspire a lot of other exchanges to also focus on derivatives.
So what is it exactly?
A perpetual swap contract is a derivatives contract that aims to closely mimic the spot price of the underlying asset. It has no expiration or settlement like traditional futures contracts do, hence the name "perpetual" swap. It's a market of its own so the price can differ, in some instances quite a bit, from the reference spot index price, however a mechanism called "the funding rate" is meant to tether the market back to the reference spot price. A perp allows market participants to trade crypto assets with leverage and speculate or hedge positions.
There are three types of perps in crypto:
linear
inverse
quanto
Linear
A linear perp is the most straight forward which is probably why it has become the most popular type, despite the fact that inverse perps came first.
A linear contract is settled and quoted in the quote currency.
For example, an LTC/USDT linear perp is settled in USDT and quoted in USDT.
Your margin, in this example, is USDT.
The volume and open interest are denominated in coins. In simple English: the open interest for a BTC/USDT perp for example is denominated in BTC. This is because with a linear perp you're going long or short a certain amount of coins. However most exchanges allow you to place position size in a USD equivalent (e.g. USDT) for convenience sake.
Inverse
An inverse perp is settled in the coin that you're trading but quoted in the quote currency.
For example, an LTC/USD inverse perp is settled in LTC, but quoted in USD.
Your margin, in this example, is LTC.
The volume and open interest are denominated in USD. This is because with an inverse perp you're going long or short a certain amount of dollars worth of the asset. This is also why it's called an "inverse" perp: it's quoted as LTC/USD, but the underlying functions as USD/LTC.
It's important to understand that inverse contracts have unfavourable convexity for longs.
Convexity is the measure of a contract's value with respect to its price.
Here's an example of a 100 000 contracts long on a BTC/USD inverse perp, entered at a price of
$10 000 with 1x leverage:
If the price drops to $5000 the long position gets liquidated while the same long position on a linear perp would only have a 50% drawdown. This is because your margin is the coin itself. If you're long and the price drops, you're not only losing money because the price is going against you, your margin (BTC in this example) is now also worth less: double rekt.
So why would anyone trade an inverse perp then?
Well first of all, they've fallen out of favour. Linear perps are king now. However...
This contract is very favourable for shorts. If you go 1x short, because of the convexity, you will literally never get liquidated.
In a bull market a lot of market participants want to hold the currency they're bullish on and also use it as collateral to enter a leveraged long position to amplify the gains. This is risky business though.
Quanto
A quanto contract is bullshit.
It's impractical and confusing and that's also why pretty much no one in crypto wants to trade these contracts. The only exchange as far as I know that offers them is Bitmex.
A quanto perp is a contract that's settled in one coin but the underlying is a different coin that's quoted in the quote currency. Bitmex's quanto contracts use BTC as margin and PNL, but you're trading a different coin like ETH for example, which is quoted in USD.
This type of contract poses incredible added risk compared to a linear or inverse perp because you have to pay attention to the price action of both the coin that's used as margin (BTC) and the coin that you're actually trading (e.g. ETH). This contract is especially tricky for shorts, who can very easily get liquidated.
The reason why shorts easily get liquidated is that your margin is BTC. So let's say that you're short on the ETH/USD quanto contract and the price of ETH starts going up. You're losing money now obviously, but BTC and ETH have very high correlation so BTC is probably going up in value at the same time. Remember, your margin is BTC so the USD value of your margin is increasing which means that the size of your position is exploding.
Because of the incredibly high risk for shorts it's normal that the funding rate of this type of perp consistently remains elevated.
Terminology
Base currency
The base currency is the currency that you're trading. For example, if you're trading a BTC/USDT perp, the base currency is BTC.
The base currency is also sometimes called "home currency".
Quote currency
The currency in which the price of the contract is expressed. To figure out what the quote currency is simply look at the second part of the ticker. If the ticker is "BTC/USDT" for example then the quote currency is tether (USDT).
Margin currency The margin currency is also the PNL currency, it's the same currency as the default margin that is used for the contract. Basically the currency that you're using to enter trades is the margin/PNL currency.
However a lot of exchanges changed their collateral rules to make them more flexible which means that a lot of, mostly linear, contracts now accept multiple different currencies as collateral. Regardless there's always a default margin currency though.
For inverse contracts the default margin currency is the coin itself, for linear perps it's usually a USD equivalent like USDT for example, and for quanto contracts it's usually BTC but it could also be something else. Always look at the contract specifications.
Multiplier
The multiplier represents the value of 1 contract. Remember that with perps you're buying or selling contracts.
These rules are different for every exchange so it's important to look at the contract specifications.
However, often the multiplier for inverse contracts is $1 and for linear contracts it's 1 coin (e.g. 1 BTC).
This means that a contract of an inverse perp is worth $1 and for linear perps each contract is worth its price in the quote currency.
The minimum trade amount isn't necessarily the same as the multiplier though. For example, most exchanges use 1 BTC as the value of 1 contract for their BTC/USDT linear perp, but the minimum trade amount is in most cases 0.001 BTC.
Maintenance margin
The minimum amount of margin required to keep your positions open.
Margin balance
Wallet balance + unrealised PNL.
PNL
Profit and loss from positions. UPNL is unrealised PNL which means that you haven't closed the trade yet so the profit or loss hasn't been realised yet.
Index price
The price of a, typically volume, weighted spot index. The index price is meant to represent a fair average price of the spot market.
Last price
The last price is simply the last price that the perp traded at.
Mark price
The mark price is a combination of the index price and a moving average basis. This is meant to create a more smoothed out and fair average price. The mark price determines uPNL and liquidations.
Premium index
The premium index tracks the premium or discount of the last price of the perp relative to the mark price.
Funding rate
The funding rate is a mechanism based on the premium index that's meant to help tether the last price to the index price. It could be considered some sort of interest that either longs or shorts have to pay to their counterparty (not the exchange, the exchange makes no money on this).
Most exchanges hold funding payouts every 8 hours, which means 3 times a day. There's always a countdown to the next payout, if you enter and exit a trade between those intervals you won't have to pay funding, but you also won't receive funding.
If the perp trades above the spot index price then funding will be positive.
If the perp trades below the spot index price then the funding will be negative.
If funding is positive longs have to pay shorts.
If funding is negative shorts have to pay longs.
Most exchanges use a "clamp". A clamp is a default funding percentage that the funding rate ankers to when the last price is very close to or the same as the index price. We also call this "baseline". Most exchanges set the baseline at 0.01% funding per 8 hours.
The funding rate's effect is twofold.
Let's say as an example that the perp that we're trading is disconnected from the spot market, it's trading well above the spot price. Funding is very much positive now.
This is an incentive for longs to close their positions because they have to pay just to keep their positions open.
It's also an incentive for more shorts to enter the market because they could get paid funding just for having a position open.
Because of this the market will balance itself out and the last price of the perp will eventually snap back to the underlying spot index price.
Predicted funding rate
Exchanges constantly calculate and estimate what the next funding rate is going to be, based on current price action.
That's it for this post.
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