Perpetual Future Contracts Explained

To understand the functions of a Perpetual Future Contract it is important to first fully understand the meaning of a future contract. A futures contract is an arrangement to buy or sell a commodity, currency, or another tool at a prearranged price at a definite time in the future.

Unlike an old-fashioned spot market, in a futures market, the trades are not ‘settled’ promptly. Instead, two counterparties will trade a contract, that defines the clearance at a future date. Also, a futures market doesn’t allow users to unswervingly purchase or sell the product or digital asset. Instead, they are trading a contract representation of those, and the actual trading of assets (or cash) will happen in the future - when the contract is exercised.

As a simple example, consider the case of a futures contract of a physical commodity, like wheat, or gold. In some traditional futures markets, these contracts are marked for delivery, meaning that there is a physical delivery of the commodity. As a consequence, gold or wheat has to be stored and transported, which creates additional costs (known as carrying costs). However, many futures markets now have a cash settlement, meaning that only the equivalent cash value is settled (there is no physical exchange of goods).

Additionally, the price for gold or wheat in a futures market may be different dependent on how far is the contract settlement date. The longer the time-gap, the higher the carrying costs, the larger the probable future price uncertainty, and the larger the potential price gap between the spot and futures market.

Perpetual Future Contract

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

Thus, unlike conservative futures, perpetual contracts are often traded at a price that is equal or very similar to spot markets. Still, the principal difference between the traditional futures and perpetual contracts is the ‘settlement date’ of the former.