Backdrop

Perpetual futures are the hottest derivative in town, accounting for markedly more trading volume than spot markets and orders of magnitude more trading volume than options markets.

30-day moving average of the BTC spot-to-futures

30-day moving average of the ETH spot-to-futures volume ratio

Overview

Perps — like all derivatives — derive their value from underlying assets and can be used for a variety of purposes, including leverage, speculation, arbitrage, and hedging. In the case of dated futures, contract prices converge on spot prices as expiries draw closer. Perps, on the other hand, do not expire and therefore have no settlement or delivery date, so an alternative mechanism must exist to incentivize the tracking of the underlying asset.

Funding Rates

Enter funding rates; the mechanism that binds the price of a perp to the price of spot. Funding rates are represented as a positive or negative percentage, determined by the discrepancy between the price of a perp and the price of spot.

• When the funding rate is positive, the perp is trading at a premium relative to the price of its underlying asset

• When the funding rate is negative, the perp is trading at a discount relative to the price of its underlying asset

In dated futures markets, contracts trading at a premium are in contango while contracts trading at a discount are in backwardation. With perps, we do away with dates, contango, and backwardation. Instead, it’s just positive or negative funding rates.

Funding Payments

Funding payments are dictated by the positivity or negativity of the funding rate and ensure that perps trade on par with spot. The greater the disparity between the price of a perp and spot price, the higher funding rates will be. When the funding rate is positive, long contracts are trading at a premium and shorts collect funding payments from longs. When the funding rate is negative, short contracts are trading at a premium and longs collect funding payments from shorts.

The funding rate is extrapolated from a 24hr realization period (i.e., the fee traders could expect to be debited or credited every 24hrs). Over 24 hours, longs pay shorts based on the following formula:

The impact midpoint is the midpoint of the bid-ask spread, given $1k worth of quotes on both sides of the spread

Funding Payment Example

You buy (long) 100 SOL-PERP contracts and sit in your position for 24hrs. Over that time, the impact midpoint is $11.76, and the SOL oracle price is $12. The resulting funding rate would be -2%, and your long position would receive $24/day in funding payments.

An example of a trader buying (longing) a SOL perp and receiving funding payments in a negative funding rate environment

Margin

Trading on Zeta, you have $SOL, $BTC, and $ETH subaccounts. Your subaccounts are sequestered, but all positions within a given subaccount are cross-margined — reducing the frequency but not the magnitude of liquidations, by lowering your margin maintenance level.

Each Zeta subaccount has two risk parameters.

1. Initial Margin: the collateral required to open a position (10% of spot price)

2. Maintenance Margin: your liquidation threshold (6.5% of spot price)

USDC is the quote asset for all trading pairs on Zeta and your account equity includes deposited USDC. If one of your subaccounts is approaching your margin maintenance level, you can reduce your risk of liquidation by topping up the at-risk subaccount with USDC.

Open Interest (OI)

Open interest (OI) refers to the total number of unsettled contracts and sheds light on capital flow. The transfer of contracts does not alter OI. OI changes only when contracts that did not previously exist are created, or when existing contracts are closed.

Generally, increasing OI signals fresh capital flowing into the market, whereas declining OI signals capital flowing out of the market. Higher OI is naturally correlated with higher liquidity.

Liquidations

What are cascading liquidations? An old wives’ tale?

Cascading liquidations are a phenomenon that occurs when the liquidation of one trader’s position causes a domino effect, triggering the liquidation of subsequent traders’ positions.

Market events often incite liquidation cascades, leading to sharp upward or downward price action. Trading perps with leverage in turbulent markets can result in substantial profits, or getting your back blown out, depending on which side of the contract you’re on.

Two primates on opposite sides of a perpetual contract; one primate (top of frame) realized a sizeable profit in the wake of a liquidation cascade while the other (bottom of frame) may have to close up shop

Zeta Perpetual Contracts Schema and Specifications

Conclusion

If you’re keen to get in on the action, head over to dex.zeta.markets to manage risk, trade with leverage, or collect funding while trading basis. And while you’re there, check out our weekly rewards programs. They are generously configured for both makers and takers.

We owe a personal thanks to Robert Shiller for conceiving perpetual futures in 1992, predicting the ’08 housing bubble, and being an active member in our Discord.

And lastly, an AI-generated, feel-good story about a young man named Zeta Intern who changed the trajectory of his life by taking advantage of inefficiencies in crypto markets.