In DeFi, perpetual contracts are powerful tools for traders seeking greater flexibility and more sophisticated trading strategies.
Perpetual contracts are among the most versatile financial instruments within blockchain, attracting sophisticated traders and liquidity providers alike. In this installment of our DeFi 101 series, we dive into the benefits and mechanics of perpetual contracts, exploring how they empower users to maximize DeFi opportunities. If you’re new to this series, be sure to check out our previous guides:
탈중앙 금융 101: 유동성 스테이킹 토큰이란 무엇인가요?
DeFi 101: The role of stablecoins in DeFi
Now, let’s explore perpetual contracts in more depth.
What are perpetual contracts?
Perpetual contracts – or “perps” – are a type of financial derivative that allow traders to speculate and bet on the price of assets without needing to hold the underlying asset itself. In many ways, perps work similarly to traditional financial derivatives like futures contracts. However, unlike regular futures contracts, perps do not have expiration dates.
The absence of expiration dates means that traders have the flexibility to hold their positions indefinitely, as long as they maintain the required margin. A funding rate mechanism ensures that the contract price remains aligned with the spot market price through regular payments made between long position and short position holders. When the funding rate is positive, traders holding long positions pays those holding short positions, and when funding rate is negative, short positions pay long positions. Effectively, this can be seen as the interest that traders pay or earn, depending on whether they are borrowing or providing assets, and depending on what the funding rate is.
This combination of flexibility and leverage makes perps a go-to choice for traders looking to maximize opportunities within DeFi.
Perps provide traders several advantages over spot trading and traditional financial derivatives.
What advantages do perpetual contracts provide in DeFi?
Perps are powerful DeFi tools that unlock new opportunities for traders:
Leverage trading: Perps enable traders to amplify their market exposure through leverage, which lets them control larger positions with a smaller amount of capital. For instance, 10x leverage would allow a trader to open a $10,000 position using just $1,000 of collateral. Leverage trading lets traders capitalize on even the smallest price movements. Note that leverage increases the risk of losses, as decreasing price movements are also amplified. Higher leverage means higher risk.
Short selling: Perps allow traders to take short positions, which means they are effectively betting against an asset’s price. If asset prices drop, traders can close their positions at the lower prices and profit from declining asset prices. Short selling offers traders the opportunity for gains during market downturns, and also allows them to hedge their portfolio to offset potential losses on long positions.
Hedging strategies: By taking a position opposite to their current holdings, traders can use perps as a hedge against unfavorable price movements. This can be a valuable tool to manage risk during market volatility. For instance, a trader holding a large Bitcoin position can hedge against potential losses by opening a short perp position, which will minimize the impact of a price drop and give the trader a chance to profit on a short position without having to sell their Bitcoin holdings.
Delta-neutral yield strategies: Perps are useful to those looking to run basis trades, which is a strategy used by protocols like Ethena to generate delta-neutral yields. This involves taking opposite positions in perps and spot markets for a low-risk return that is based on the funding rate.
Asset ownership not required: As previously mentioned, trading perps does not require a user to hold the actual token itself. As long as the trader has provided requisite collateral, they can use the collateral to trade perps of other assets, which provides flexibility.
Deeper liquidity: Perps can attract more capital, liquidity providers, and sophisticated traders, which leads to deeper liquidity within a DeFi ecosystem. Deeper liquidity benefits a blockchain ecosystem and its protocols collectively by ensuring smoother trade executions, reduced slippage, and more reliable trading environments.
What are the risks associated with perpetual contracts?
While perps offer many advantages to traders, it’s important to remember that they can be very high risk financial instruments. In order to mitigate risks, perps traders should make sure they have a thorough understanding of the mechanisms behind perps. Some risks associated with perpetual contracts include:
Liquidation: Because even small adverse price movements have the potential to trigger margin calls and lead to forced liquidations of initial investments.
Complexity: Perps are sophisticated financial tools that require an understanding of leverage, funding rates, and overall risk management. While perps are accessible by anyone, it’s recommended for advanced traders.
High volatility: The higher the leverage used for trading, the higher the associated risks. The same mechanism that allows for higher gains can also work against the trader if the price of the underlying asset moves in the opposite direction of a trader’s position. Perps are therefore more impacted by market swings.
Variable funding rates: As funding rates are dynamic and can vary significantly based on the trading venue and the ratio of long to short positions, this can add extra risk. For instance, funding rates often increase as the demand for long positions increases. This creates an imbalance, as long position holders have to make larger payments to short holders. High funding rates can be expensive, especially when annualized. As funding rates increase, this could lead to long positions on perps being more costly than borrowing funds directly through lending protocols. However, note that perps will still provide more flexibility than lending protocols.
Are perps available on Flare?
With the recent launch of SparkDEX Eternal, Flare has introduced perpetual contracts to its ecosystem for the first time, providing Flare users with the opportunity to integrate perps into their DeFi strategies. SparkDEX Eternal was designed to cater to both advanced traders and liquidity providers.
Key benefits of SparkDEX Eternal:
- Up to 100x leverage
- Automated conditional orders (stop-losses, take-profits, trailing stops, protect order and reduce only)
- Wide selection of popular cryptocurrencies
- Liquidity sourced from 12+ chains for optimal trade execution
- Unique pools supporting every asset on the platform
- Customizable management of open interest
Because SparkDEX Eternal leverages the Flare Time Series Oracle (FTSO) for highly accurate and decentralized data, SparkDEX Eternal can ensure precise and reliable funding rate calculations, which are essential for a perps platform to run efficiently.
How do perps benefit Flare’s DeFi growth?
Perps are some of the most traded derivatives in the cryptocurrency space. By integrating perps into its ecosystem, Flare appeals to sophisticated traders and liquidity providers, paving a path to a more robust environment for DeFi innovation. The deeper liquidity and increased on-chain activity generated by perps trading will enhance the overall health of the larger Flare DeFi ecosystem.
Additionally, perps are also among the main drivers of oracle usage in the blockchain industry, and therefore a perfect opportunity to position Flare as a leading blockchain solution for more sophisticated DeFi solutions.
If you’re interested in adding perps to your DeFi strategy, explore the SparkDEX Eternal panel to get started.