Terminology Know

Perpetual Futures Contracts

A perpetual contract is a special type of futures contract, but unlike the traditional form of futures, it doesn’t have an expiry date. So one can hold a position for as long as they like. Other than that, the trading of perpetual contracts is based on an underlying Index Price. The Index Price consists of the average price of an asset, according to major spot markets and their relative trading volume.

Thus, unlike conventional futures, perpetual contracts are often traded at a price that is equal or very similar to spot markets. However, during extreme market conditions, the mark price may deviate from the spot market price. Still, the biggest difference between the traditional futures and perpetual contracts is the ‘settlement date’ of the former.

Initial Margin

Initial margin is the minimum value you must pay to open a leveraged position. For example, you can buy 1,000 BNB with an initial margin of 100 BNB (at 10x leverage). So your initial margin would be 10% of the total order. The initial margin is what backs your leveraged position, acting as collateral.

Maintenance Margin

Maintenance margin is the minimum amount of collateral you must hold to keep trading positions open. If your margin balance drops below this level, you will either receive a margin call (asking you to add more funds to your account) or be liquidated. Most cryptocurrency exchanges will do the latter.

In other words, the initial margin is the value you commit when opening a position, and the maintenance margin refers to the minimum balance you need to keep the positions open. The maintenance margin is a dynamic value that changes according to market price and to your account balance (collateral).

Liquidation

If the value of your collateral falls below the maintenance margin, your futures account may be subject to liquidation. Depending on the exchange you use, the liquidation occurs in different ways. In general, the liquidation price changes according to the risk and leverage of each user (based on their collateral and net exposure). The larger the total position, the higher the required margin.

To avoid liquidation, you can either close your positions before the liquidation price is reached or add more funds to your collateral balance - causing the liquidation price to move further away from the current market price.

Funding Rate

Funding consists of regular payments between buyers and sellers, according to the current funding rate. When the funding rate is above zero (positive), traders that are long (contract buyers) have to pay the ones that are short (contract sellers). In contrast, a negative funding rate means that short positions pay longs.

The funding rate is based on two components: the interest rate and the premium. The interest rate may change from one exchange to another, and the premium varies according to the price difference between futures and spot markets.

In general, when a perpetual futures contract is trading on a premium (higher than the spot markets), long positions have to pay shorts due to a positive funding rate. Such a situation is expected to drive the price down, as longs close their positions and new shorts are opened.

Mark price

The mark price is an estimate of the true value of a contract (fair price) when compared to its actual trading price (last price). The mark price calculation prevents unfair liquidations that may happen when the market is highly volatile. So while the Index Price is related to the price of spot markets, the mark price represents the fair value of a perpetual futures contract. Typically, the mark price is based on the Index Price and the funding rate - and is also an essential part of the “unrealized PnL” calculation.

PnL

PnL stands for profit and loss, and it can be either realized or unrealized. When you have open positions on a perpetual futures market, your PnL is unrealized, meaning it’s still changing in response to market moves. When you close your positions, the unrealized PnL becomes realized PnL (either partially or entirely).

Because the realized PnL refers to the profit or loss that originates from closed positions, it has no direct relation to the mark price, but only to the executed price of the orders. The unrealized PnL, on the other hand, is constantly changing and is the primary driver for liquidations. Thus, the mark price is used to ensure that the unrealized PnL calculation is accurate and just.