What is a Perpetual Contract?

Perpetual contracts, often simply referred to as "perps," are a type of linear derivative that allow traders to use leverage to speculate on the price of an underlying asset. A derivative is usually a contract between two parties that determines a final payout based on the price of an underlying asset at a set expiry date. Perpetual contracts, as the name suggests, have no expiry dates, and can be held indefinitely.

Derivatives are widely used by traders to get exposure to an underlying asset without holding that underlying asset directly. For example, if a trader wishes to short Bitcoin without a derivative, they would need to own Bitcoin in order to sell it–with a derivative, they could just use USDC to fund the trade. Perps combine the general flexibility of cash-settled derivatives with the ability to keep positions open indefinitely as long as enough margin is maintained to avoid liquidation. Perps also introduce funding rates, which are periodic payments exchanged between buyers (long positions) and sellers (short positions), opening the door to new trading strategies and arbitrage opportunities between perp and spot markets.

Perps were initially pioneered by BitMEX in 2016, inspired by traditional finance’s Contracts for Difference (CFDs). Before the introduction of perps, traders were limited to either spot (no leverage/shorting) or traditional futures contracts (need careful management of position expiries). The introduction of perps helped to eliminate the hassle of contract expiries in traditional futures, making a derivative that is simple and approachable enough for spot traders. Perps quickly gained traction after their introduction, and other exchanges began adopting and offering their own versions of perpetual contracts. Since 2016, perps have become a staple of the crypto trading ecosystem, acting as a versatile tool for a wide range of trading strategies. While perps are still most commonly traded on centralized cryptocurrency exchanges, decentralized perps platforms are becoming more and more popular.

What are Perps Good For?

Perps offer a number of advantages to traders over spot trading, including the ability to use leverage and open short positions–all while retaining comparable simplicity to spot trading.

First, the simple design of perps makes them ideal for both beginning and seasoned traders. The absence of expiry dates means traders can hold positions for as long (or as short) as they want, and funding rates are a straightforward mechanism that can be easily understood and incorporated into trading strategies. Further, perps are a linear derivative, meaning that a 1 unit change in spot price is generally equivalent to a 1 unit change in the perp price. This drastically simplifies the use of perps in hedging and speculation when compared to other nonlinear derivatives. The fundamental concept of “long if bullish and short if bearish” is intuitive and widely understood, helping make perps accessible to a wide range of traders, from retail to institutions.

Perps also introduce funding rates, which can create arbitrage opportunities between perp and spot markets that bring in liquidity. In order to keep the price of the contract tethered to the spot price of the underlying asset, funding payments are made between buyers and sellers. This mechanism not only incentivizes price parity between the underlying asset and the perpetual contract, but can also occasionally attract liquidity by allowing traders to hedge short positions with spot holdings (or vice versa) to receive relatively risk-free gains, depending on the direction of the rate.

Perp-ifying Everything

While originally conceived for crypto underlyings, perps hold the potential to greatly improve trading across various asset classes. By "perp-ifying" other markets that have been historically difficult to trade, such as predictions, hashrates, NFTs, volatility, interest rates, and more, traders could enjoy the benefits of perps–simplicity, leverage, and shorting–across a set of markets that are otherwise inaccessible.

The future of perp-ification unlocks a plethora of new use-cases and opportunities for traders. Hashrate perp markets, for example, could be used by institutional and retail crypto miners to hedge their operations. Prediction perp markets could attract much deeper liquidity, making them significantly more efficient and reliable than existing betting platforms. Even the most illiquid assets, like works of physical art, could be perp-ified into an efficient market trading real-world asset (RWA) underlyings. There are many markets that are widely watched, such as volatility indices, that even professionals will refuse to trade due to the risk and complexity currently associated with them. If traders were simply able to trade a linear volatility perp and set up a position with a stop loss, volatility could become a much more popular and widely traded market.

While the potential to bring perps to new markets is massive, it is not without challenges. On the technical side, creating perps for new asset classes requires reliable mechanisms to ensure accurate and efficient pricing, settlement, and liquidations–especially for highly volatile or novel markets. This involves developing new algorithms for funding rates, ensuring platform security, designing new instruments, and finding reliable price feeds to create oracles. However, even with all of this infrastructure, the largest challenge is consistently sourcing liquidity, especially in the case of introducing a new structure (hashrates, for example). At Variational, we’re combining a novel protocol design and a unique liquidity provider called OLP that sources liquidity from CEXs, DEXs, DeFi, and OTC markets to ensure that exotic markets are not only listed, but liquid.

Conclusion

Perps have already transformed the landscape of crypto trading, providing a flexible, liquid, and efficient trading instrument. By functioning as a straightforward linear derivative for leveraged speculating and hedging via shorts, perps have become a versatile tool for traders. The potential to extend these benefits to a huge variety of long-tail and exotic assets can further revolutionize financial markets, if certain technical hurdles can be overcome.

At Variational, we’re building decentralized infrastructure to drive the next generation of trading. Variational is a peer-to-peer trading protocol for perpetuals and generalized derivatives. Omni, the first app built on Variational, is a retail-focused perps trading platform currently in testnet.

Omni allows users to trade perpetuals on thousands of underlying assets, including new, thinly traded, and pre-market tokens. The long-term vision for Omni is to support perps on everything–from points and predictions to volatility and validator rewards. Omni maximizes day-one liquidity with OLP, meaning you never have to worry about thin or empty order books. The Omni Liquidity Provider also accepts community deposits, enabling loss rakebacks and enabling any user of Omni to benefit from the success of the platform. If you’re interested in giving Variational Omni a try, visit the website today.