Today we are going to talk about the 'perpetual contract,' which most people love and hate.
Perpetual contracts, also known as 'preps', 'perpetual swaps,' can be considered a type of tool, as they are essentially a financial derivative in cryptocurrency.
Perpetual contracts are quite similar to contracts for difference (CFD), but the former does not expire. Traditional futures like E-mini S&P 500 have an expiration date of 3 months, while gold or oil expires monthly. There are also quarterly expiration contracts in cryptocurrencies, but their liquidity is certainly not as good as perpetual contracts. Perpetual contracts are mainly used for delta-neutral trading by large traders, as they carry no risk and never expire, allowing for long-term leverage positions with funding rates.
Perpetual contracts are mainly divided into two categories: one is inverse futures, and the other is linear contracts.
Today we mainly discuss linear futures, which are basically what everyone uses; that is, quoting and settling in the quoting currency, and most exchanges use stablecoins.
Perpetual contracts are generally traded with leverage.
Coincidentally, we just talked about 'liquidation,' which is commonly known as a margin call.
Have you ever thought about why liquidations happen, what the underlying logic of liquidation is, and how they can be avoided? We will answer that next.
For example, if you want to go long on a BTC futures contract currently priced at $100,000, but your account only has $10,000, then if you want to go long 1 BTC, you can use 10x leverage, and the exchange will provide the remaining BTC.
At this point, your $10,000 is used as margin to open a long position of 1 BTC.
If Bitcoin drops to $92,000 after a while, you will lose $8,000, and since the exchange does not want to lose its own money, you will receive a margin call notification.
If you add more margin, you will maintain your position unchanged. But if you take no action and when the Bitcoin price continues to drop to $90,000, the exchange will automatically liquidate your position, a step known as 'liquidation.'
It is worth mentioning that as we stated earlier, perpetual contracts are traded with leverage, and most exchanges offer leverage options from 1-100x.
If you use 10x leverage to establish a position, the market must move 10% against you to be liquidated; but if you use 100x, the market only needs to move 1% against you for you to be liquidated.
At the same time, we notice that when the platform performs a liquidation action, it executes your order at the market price. This may trigger a 'liquidation cascade' because the current market liquidity is insufficient to meet the demand for the current liquidation quantity (a surge in market orders), leading to matching all orders at higher or lower prices until completed. However, reality is often more complex than the ideal situation.
The topic of liquidity will be mentioned in the next chapter, this chapter ends here, thank you for your viewing and recording.