# Perpetual Basics

### Mastering the Basics: An Introduction to Derivatives

Derivatives are financial instruments based on an underlying asset, such as a currency, commodity, or stock. They allow investors to speculate on the future price movements of these assets or protect against potential price fluctuations.

Various derivatives include futures, options, Perpetuals, and forwards. Each type has its own unique characteristics and uses, but they all enable investors to speculate on the future price of an underlying asset or hedge against price changes. Here we will discuss only perpetual, as our product is based on perpetuals.

### Perpetuals Uncovered: Everything You Need to Know

Perpetuals are a type of derivative contract that allows traders to speculate on the future price of an underlying asset with no expiration date. They are similar to traditional futures contracts but do not have a fixed expiration date. Instead, they use a mechanism called "funding" to keep the contract's price in line with the spot price of the underlying asset.

### How Does a Perpetual Contract Work?

1. Perpetual futures are based on the underlying asset's spot price. This means that the price of the perpetual futures contract is closely tied to the current market price of the underlying asset, such as a cryptocurrency or commodity.
2. They are traded on a cryptocurrency exchange. Traders can buy or sell perpetual futures contracts on these platforms, just like they would with any other security.
3. They use a mechanism called "funding" to keep the contract's price in line with the spot price. This mechanism ensures that the price of the perpetual futures contract does not deviate too far from the spot price of the underlying asset.
4. Perpetual futures contracts can be leveraged, meaning traders can control a larger position with less capital. However, this also increases the risk of loss if the trade goes against them.
5. There is no expiration date on perpetual futures contracts, so traders can hold them for as long as they wish. However, traders will need to pay or receive funding periodically to keep the contract price in line with the spot price.
6. Traders can close their position at any time by either buying or selling an equal number of contracts.

**Let’s understand them with an example and an analogy.**

> **Example:** An example of trading in perpetual futures would be a trader who believes that the price of Bitcoin will **increase** in the future. They buy a perpetual futures contract on Bitcoin, allowing them to speculate on the future price of the cryptocurrency.
>
> The trader buys a contract for 1 Bitcoin at a price of $10,000, with leverage of 10x. This means the trader only needs to put up $1,000 of their own capital to control a position worth $10,000.
>
> If the price of Bitcoin increases to $11,000, the trader can sell the contract for a profit of $1,000 ($11,000 - $10,000). However, if the price of Bitcoin decreases to $9,000, the trader would incur a loss of $1,000.

> **Analogy:** An analogy for perpetual futures would be renting a car with no fixed return date. You pay the rental company a deposit and agree to pay a daily fee to use the car, but you can keep the car for as long as you want. Similar to the funding mechanism used in perpetual futures, you would need to pay a daily fee to the rental company to keep the car, but you are not committed to returning it on a fixed date.

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🚨❗<mark style="color:blue;">**Warning:**</mark> It is important to note that trading in derivatives such as Perpetual Futures is highly speculative and carries a high level of risk. It is important to understand the mechanics of the instrument, the underlying markets, and the risks involved before entering any trades. It is highly recommended to properly understand the markets and underlying assets, the leverage, the funding mechanism involved, and the risk management strategies before entering any trades.
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### Longs and Shorts in Perpetuals: Making Sense of Perpetuals

In Perpetual Futures, traders can take on either a "long" or "short" position depending on their market outlook.

**A Long Position** is when a trader believes that the underlying asset's price will increase in the future. The trader can open a long position by buying a perpetual futures contract, with the expectation that they will be able to sell it at a higher price in the future and make a profit.

> **Example:** If a trader buys a perpetual futures contract for 1 Bitcoin at a price of $10,000 and the price of Bitcoin increases to $11,000, the trader can sell the contract for a profit of $1,000.

> **Analogy:** The long position in Perpetual Futures can be compared to renting a house with the option to buy. You expect the house's value to increase in the future, so you rent it with the plan to purchase it later for a higher price, making a profit.
>
> Let's say you rent a house for $1,000 per month, and you can buy it after 6 months for $200,000. You believe the house's value will increase over the next 6 months, so you decide to rent it to buy it later. After 6 months, the house's value has increased to $220,000. You decide to exercise your option to buy the house and sell it immediately for a profit of $20,000. This is similar to taking a long position in Perpetual Futures, where you expect the underlying asset's price to increase in the future and open a position to sell it later at a higher price.

On the other hand, **a Short Position** is when a trader believes that the underlying asset price will decrease in the future. The trader can open a short position by selling a perpetual futures contract, with the expectation that they will be able to buy it back at a lower price in the future and make a profit.

> **Example:** If a trader sells a perpetual futures contract for 1 Bitcoin at a price of $10,000 and the price of Bitcoin decreases to $9,000, the trader can buy back the contract at a lower price, closing the position and making a profit of $1,000.

> **Analogy:** A short position in Perpetual Futures can be compared to renting a house with the option to sell. You expect the house's value to decrease in the future, so you rent it with the plan to sell it later for a lower price, making a profit.
>
> Let's say you rent a house for $1,000 per month, and you can sell it after 6 months for $200,000. You believe the house's value will decrease over the next 6 months, so you decide to rent it to sell it later. After 6 months, the house's value has decreased to $180,000. You decide to exercise your option to sell the house and buy it back immediately for a profit of $20,000. This is similar to taking a short position in Perpetual Futures, where you expect the underlying asset's price to decrease in the future and open a position to buy it back later at a lower price.

💡 **Note:** In both cases, there is a deposit that needs to be paid and a daily fee, the deposit is similar to the initial margin, and the daily fee is similar to the funding rate. In the analogy of renting a house, the deposit would be the initial security deposit paid to the landlord, and the daily fee would be the monthly rent. In Perpetual Futures, the deposit is the initial margin that needs to be paid to open a position, and the daily fee is the funding rate that needs to be paid to maintain the position.

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🚨❗<mark style="color:blue;">**Warning:**</mark> It's important to note that taking a short position also exposes the trader to the risk of unlimited losses, as there is no theoretical limit to how high the price of an asset can go. This is why it is crucial to properly understand the markets, the underlying assets, the leverage, and the funding mechanism involved, as well as to use risk management strategies before entering into any short positions.
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### Margin and Leverage: Don't Let Them Margin-ize Your Profits!

Margin and leverage are two key concepts in Perpetual Futures trading that allow traders to take on larger positions than they could with their own capital alone.

**Margin** refers to the amount of money a trader must deposit to open and maintain a position in the market. This deposit is the initial margin and serves as collateral for the position.

> **Example:** If a trader wants to open a position in Bitcoin Perpetual Futures with leverage of 10x, and the initial margin requirement is 1%, the trader would need to deposit 1% of the position's value, or $1,000, to open a position worth $100,000.

> **Analogy:** Margin in Perpetual Futures trading is a down payment on a house. When you want to buy a house, you need to make a down payment, which is collateral for the mortgage. Similarly, when you want to trade Perpetual Futures, you must make a deposit, which serves as collateral for the position.

On the other hand, **Leverage** refers to the ability to control a larger position than a trader's capital. It's the ratio of the amount of capital a trader has to the amount of capital they can control in the market.

> **Example:** If a trader wants to buy 1 Bitcoin at a price of $10,000 and they have $1,000 in their account, they would not be able to afford it. However, if they use the leverage of 10x, they would only need to put up $1,000 \* 10% (initial margin requirement) = $100 as the initial margin. They could control the same $10,000 worth of bitcoin, effectively controlling $10,000 worth of bitcoin with $100 of initial margin.

> **Analogy:** Leverage in Perpetual Futures trading is using a lever to move a heavy object. When you use a lever, you can control a larger object than you can by using your own strength alone. Similarly, when you use leverage in Perpetual Futures trading, you can control a larger position than you could with your own capital alone.

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🚨❗**Warning:** It's important to note that while leverage can increase potential profits, it also increases potential losses. Therefore, it is crucial to properly understand the markets, the underlying assets, the leverage, and the funding mechanism involved and to use risk management strategies before entering any trades.
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### Funding and Funding Rates: Don't Get "Rate-d" Out of the Game!

Funding or funding rate refers to how traders in Perpetual Futures markets can maintain the balance between long and short positions. It is the rate at which long traders pay short traders or vice versa, depending on the relative value of the two positions. This mechanism helps keep the market balanced and ensures that the futures price stays close to the underlying spot price.

> **Example:** Let's say the spot price of Bitcoin is $10,000, and the futures price is also $10,000. If the interest rate for holding Bitcoin is 0.5% and the interest rate for holding US dollars is 1%, the funding rate for holding a long position in Bitcoin futures would be -0.5% (negative 0.5%). This means that long traders would pay 0.5% to short traders; in other words, they would pay a fee to maintain their long positions. On the other hand, the funding rate would be 0.5% (positive 0.5%) for holding a short position, meaning that short traders would receive a fee for maintaining their short positions.

> **Analogy:** The funding rate in Perpetual Futures trading is a water tank. Imagine that a water tank is a market, and the water level represents the price. The water is coming in at one end and going out at the other; this inflow and outflow represent the buyers and sellers. The water tank has two holes, one on top and one on the bottom, representing the long and short traders. The water level needs to stay at the same level; this means that water needs to flow in and out at the same rate. The funding rate is like a valve regulating the inflow and outflow, ensuring that the water level stays at the same level.

💡 **Note:** It's important to note that the funding rate can be positive or negative, and it changes based on the interest rate of the underlying assets and the supply and demand of the market. Traders need to be aware of the funding rate and how it can affect their positions, and also factor in the cost of funding when considering the overall profitability of a trade.

### Liquidation: When Your Trades Run Dry

Liquidation is when the exchange or platform automatically closes out a trader's position to prevent further losses. It is typically set as a percentage below the current market price for long positions and a percentage above the current market price for short positions. This ensures that the trader's losses are limited and that the exchange or platform is protected from large losses.

> **Example:** Let's say that a trader opens a long position in Bitcoin Perpetual Futures at a price of $10,000 with a leverage of 10x. The liquidation rate is set at -5%. If the price of Bitcoin falls to $9,500, the trader's position would be automatically closed out by the exchange or platform at $9,500 to prevent further losses.

> **Analogy:** Liquidation in Perpetual Futures trading is a safety net for a trapeze artist. The trapeze artist is the trader, and the trapeze is the market. The safety net is the liquidation rate. It's there to catch the trader if they fall, or in other words, if the market goes against them. The safety net is set at a certain height. If the trader falls below that height, the net will catch them, preventing them from falling too far and getting hurt.

💡 **Note:** It's important to note that the liquidation rate can vary from exchange to exchange and platform to platform. Traders should know the liquidation rate when entering a trade and adjust their risk management accordingly. Also, it is important to note that when a position is liquidated, it can lead to additional losses known as "slippage,” which occurs when the price at which the position is closed out differs from the liquidation price. This can happen due to sudden changes in market conditions or volatility, resulting in a larger loss than the trader had anticipated.

Another thing to remember is that when a position is liquidated, the trader may have to pay additional fees, such as liquidation fees. These fees can vary from exchange to exchange, and traders should be aware of them when entering a trade and factor them into their overall profitability calculations.

### Insurance Fund: Your Safety Net in the Perpetuals Ocean

The insurance fund in perpetual serves a vital role within the trading ecosystem, primarily designed to safeguard the protocol's stability. This fund consistently holds a designated amount of capital, serving as a financial safety net for unforeseen circumstances.

For instance, consider a scenario where a sudden market fluctuation triggers a wave of trader liquidations, resulting in their account margins plummeting below the minimum maintenance threshold (6.25% in our product). In this situation, some traders may find themselves categorized as "underwater" with negative balances, while others face the possibility of immediate liquidation.

Here's where the insurance fund steps in: Its primary purpose is to restore balance to these underwater accounts. Suppose a trader's account, for instance, falls to a -2% balance. The insurance fund can cover this 2% deficit, effectively bringing the balance back to zero or even raising it to 1%. After this balancing act, the protocol has a few options. It can proceed with the liquidation process, or alternatively, it can place the account in a liquidation queue, allowing any interested party to initiate the liquidation.

Long story short, the role of an insurance fund is to maintain the protocol's stability and integrity in the face of market volatility and unexpected events.

> **Analogy:** Think of the insurance fund in this trading platform as a financial lifeguard at a swimming pool. Just like how the lifeguard's primary responsibility is to ensure the safety and well-being of all swimmers, the insurance fund's main purpose is to protect the overall health of the trading platform.
>
> Now, imagine a situation where the pool has a sudden and unexpected change in water currents, creating a dangerous situation for some swimmers. Some swimmers are struggling to stay afloat (analogous to traders with negative balances), while others are at risk of being carried away by the current (similar to those facing liquidation). The lifeguard, in this case, takes immediate action. They use a buoy (analogous to the insurance fund) to provide temporary support to swimmers in distress. For instance, if a swimmer is about to go underwater, the buoy can keep them afloat until they regain their strength or until additional help arrives.

### Slippage: When Your Trades Slip Away

Slippage is the difference between the expected price of a trade and the actual price at which the trade is executed. It occurs when the market is highly volatile or lacks liquidity, making it difficult for traders to execute trades at their desired prices.

> **Example:** A trader wants to buy 1 BTC at $10,000, but the market is highly volatile, and the price jumps to $10,100 before they can execute the trade. The trader has experienced a slippage of $100.

> **Analogy:** This would be similar to going to the store to buy a loaf of bread at $2, but when you get there, the price has increased to $2.50 due to a lack of supply.

### Don't Let Perpetuals Sink Your Portfolio: A Note on Safe Trading

It's important to note that Perpetuals also come with certain risks that traders should know before entering a contract.

1. **Leverage Risk:** One of the main risks associated with perpetuals is leverage risk. Perpetuals are often traded with high leverage, meaning that traders can enter large positions with relatively small amounts of capital. This can lead to large losses if the market moves against the trader's position. Traders should be aware of the leverage they are using and its potential risks.
2. **Liquidation Risk:** Another risk associated with Perpetuals is liquidation risk. If the value of an asset drops below a certain level, the trader's position may be liquidated, resulting in a loss. Traders should know the maintenance margin requirements and the potential for liquidation before entering into a contract.
3. **Volatility Risk:** Volatility is another risk associated with Perpetuals. The value of an asset can fluctuate rapidly, leading to large losses for traders who are not prepared for the volatility. Traders should be aware of the potential for volatility and take steps to manage their risk accordingly.
4. **Funding Rate Risk:** Perpetuals are traded with a funding rate, the rate at which long traders pay short traders or vice versa. This can lead to additional costs for traders if the funding rate is unfavorable. Traders should know the current funding rate and its potential to change before entering into a contract.
