The Need for the Perpetual Market in the Spot Market
Every token deserves a perpetual market.
Perpetual contracts are perpetual in nature, meaning they do not have an expiration date like traditional futures contracts. Instead, they aim to closely track the underlying spot market by utilizing a funding mechanism to maintain a price that is in line with the spot market price. The funding mechanism ensures that the perpetual contract’s price converges towards the spot price over time.
Perpetual markets have gained popularity for their multifaceted benefits. They offer continuous trading options, allowing traders to engage without concerns about contract expirations or the possession of actual tokens. Additionally, perpetual markets contribute to increased liquidity, effectively mitigating the impact of slippage.
Spot & Perpetual
An analogy to describe the relationship between the spot market and perpetual market could be that of a “tethered kite”. Imagine the spot market as the kite flying freely in the sky, representing the actual market price of a cryptocurrency. The spot market is influenced by various factors such as supply, demand, news, and sentiment, which can cause the price to fluctuate.
Now, picture the perpetual market as the string that keeps the kite in check and prevents it from flying too far away. The perpetual market is designed to stay closely linked to the spot price through mechanisms like funding rates. When the kite (spot price) tries to soar too high, the string (perpetual market) pulls it back down, and when the kite dips too low, the string prevents it from falling too far. This dynamic balance ensures that the kite (perpetual contract) maintains a close connection to the movements of the spot price.
Perpetual market as an extension of spot market
The perpetual market can be seen as an extension of the spot market, offering additional opportunities and dynamics for traders and investors. The reason being the existence of a perpetual market adds another layer of speculative trading to the ecosystem. Traders can speculate on the price movements of the underlying cryptocurrency without owning the actual asset. This speculative activity contributes to price discovery by reflecting the collective sentiment of market participants.
Overall, the perpetual market enriches the trading ecosystem by offering a mechanism for speculation, risk management, and price exposure. It complements the spot market by providing traders with more diverse tools and opportunities, which collectively contribute to a deeper understanding of market sentiment and price dynamics.
Perpetual market as the absorber of slippage
In traditional spot markets, executing large trades can lead to slippage, where the execution price deviates significantly from the intended price due to market impact. Perpetual markets, by offering higher liquidity with leverage and continuous trading, can help reduce slippage when executing large orders on the spot market.
Perpetual market as the extra layer liquidity pool
Two markets shall create the arbitrage opportunity. Arbitrage opportunities arise when there are discrepancies in prices between two related markets. In the context of a perpetual market and a spot market, these two markets can create arbitrage opportunities due to price divergences.
Arbitrage trading acts as a stabilizing force in the market by helping to reduce discrepancies between the perpetual contract price and the spot price. It can work both ways, whether the spot price is increasing or decreasing.
When the spot price drops and there’s a significant difference between the spot price and the perpetual contract price, arbitrageurs may step in to take advantage of the price disparity. If the spot price is lower than the perpetual contract price, traders could buy the cryptocurrency on the spot market and simultaneously sell it on the perpetual market, profiting from the price difference. This arbitrage activity tends to bring the two prices closer together, helping to stabilize the market and prevent the perpetual contract price from deviating too far from the spot price.
Similarly, if the spot price experiences a sudden increase, arbitrageurs could buy the perpetual contract and simultaneously sell the cryptocurrency on the spot market to profit from the price difference. This would have the effect of pulling the perpetual contract price upwards and aligning it with the spot price.
Engaging in arbitrage trading helps redistribute liquidity from one side of the market to the other, effectively augmenting liquidity and deepening the overall market depth compared to a single spot market.
In essence, a well-designed perpetual market bridges the gap between the spot market and traditional futures markets. It combines the benefits of continuous trading, risk management, speculation, and price efficiency to provide traders with a versatile instrument for managing their exposure to cryptocurrency price movements.
Every token deserves a perpetual market.