# Perpetuals and Options By [Via Labs](https://paragraph.com/@viaexchange) · 2023-05-25 --- Perpetual contracts, similar to futures contracts in traditional finance, allow traders to speculate on the underlying assets with leverage without worrying about expiration dates or delivery risks. Traders deposit a margin to trade these contracts, and they can take both long and short positions on the assets. Perpetual contracts are implemented in various ways, ranging from centralized exchanges to decentralized exchanges (DEXs), but they typically share four key elements: 1. Mark Price: This represents the current value of the perpetual contract and is based on its trading price. It is crucial for calculating profit and loss and triggering liquidations. 2. Index Price: This represents the spot price of the underlying asset and is usually calculated as a weighted average based on the trading prices of the asset on major exchanges. The fundamental goal of a perpetual contract is to closely align its value with the spot value of the underlying asset, disregarding factors like trading rewards. Ideally, the mark price should be approximately equal to the index price. For example, in traditional futures contracts, they have a specific expiration date, where the value of the futures contract converges to the spot value of the underlying asset as the expiration approaches, perpetual contracts (perps) do not have an expiration date. As a result, the value of a perpetual contract, represented by its mark price, can diverge from the value of the underlying asset, represented by the index price. To address this, a mechanism is needed to bring the mark price back towards the index price and maintain its proximity to the underlying asset's value. ### Funding and How it Works **Funding is an interest payment based on a percentage of a trader's position size after accounting for leverage**. It involves variable payments from long position holders (Bulls) to short position holders (Bears) when funding is positive and vice versa when funding is negative. As you might understand, there should be a balance. That's why Funding exists, and it is only profitable for one side of a trade on the market. To balance the demand between long and short positions, funding rates attract traders to take positions on both sides by funding rate and by mark price. Those people are called Arbitragers or Delta Neutral Yield Hunters this is because they open an exposure not just to short or long the market but for obtaining a funding and to make it profitable for them. ### Who pays you when you win, and who gains when you lose In the world of cryptocurrency trading, various platforms offer innovative solutions to enhance liquidity provision and trading opportunities. GMX, Pika, Gains Network (GNS), and Kwenta are some of the platforms that employ different approaches to facilitate trading. Each platform has its own distinctive features and mechanisms to mitigate risks and maximize capital efficiency. Let's explore these platforms further to gain a better understanding of their operations and benefits. GMX facilitates trading through a multi-asset pool known as GLP (GMX Liquidity Provider Tokens). The GLP pool comprises approximately 50-55% stablecoins, 25% ETH, 20% BTC, and 5-10% other altcoins like Chainlink and Uniswap. Users can contribute liquidity to the pool by minting GLP tokens. In return for minting GLP, users earn 70% of all fees generated on the specific blockchain. Notably, unlike certain liquidity pools, GLP does not experience impermanent loss, which can negatively impact the value of assets held in a liquidity pool over time. Pika, on the other hand, utilizes a bit different approach with deposits in the vaults that are not risk-free. Where your rewards always go up, but your deposit could either go up or down based on the profits for traders. If traders are making large profits, you could lose a large percentage of your deposit and no reimbursement will be given. Gains Network has the same approach as Pika but with gDAI, a bearing token for their vault. The vault serves as the counterparty to all trades made on the platform. When traders win (positive PnL), their winnings are received from the vault and vice versa. Kwenta has a bit similar approach like GNS, but it has a massive foothold in the form of Synthetix with its sUSD. In Kwenta, the Synthetix pool acts as the counterparty for trading like Pika or GNS. Takeaways: * GMX does not have a similar counterpart as Kwenta/Pika/GNS. Kwenta implements a funding rate mechanism that GMX does not have. Additionally, Kwenta utilizes sUSD-margined perpetual contracts, while GMX has GLP, which is multiple cryptocurrencies as margined assets. * All perps employ an oracle-fed mark price which is pegged to the index. * GMX sets position limits to maintain a roughly 1:1 ratio with the collateral in the pool. Kwenta partially mitigates price volatility risk through its funding rate mechanism, enabling higher capital efficiency. Funding ------- **Funding reduces trade profitability in case the skew is not on your side and increases the risk of liquidation.** For instance, even with stable prices, an hourly funding rate of 1% translates to ±8760% annualized funding. When combined with liquidation buffers and fees, traders may face liquidation within 4 days, regardless of price movements. Leverage amplifies these risks since funding is charged based on the notional position size, affecting collateral proportionally. With the risks that funding carries, it also offers advantages. Traders who receive funding on the opposite side of their trades can boost their profit and loss (PnL). This can be used in complex trading strategies such as Delta Neutral Strategies with options like Lyra has. On the other hand, common strategies utilizing funding include basis trading and funding rate arbitrage, which aim to balance the exposure between long and short positions. For example, on Kwenta, funding is not directly tied to the skew (imbalance between long and short positions), it is a mix of skew with Open Interest (OI) but the skew is used to calculate the velocity of the funding rate. > More precisely, it's the skew in absolute terms rather than relative terms. Meaning funding rate velocity depends on the dollar value of the imbalance, not the percent value of the imbalance. - Burt Rock * If the skew is long, funding increases; * If it is short, funding decreases; * And if it is neutral, funding remains unchanged. If ETH has $2,000 more short OI than long OI, then funding rate will be moving down slowly. If ETH has $2,000,000 more short OI than long OI, it will be moving down quickly. In either case, it's possible for funding to be positive, neutral, or negative, though the longer this imbalance remains, the lower the skew will move, and the more likely it becomes that funding will be negative. Funding does not immediately adjust with changes in skew due to the entry or exit of large traders, but it will change over time if the skew persists. Certain assets may have consistently positive or negative funding rates even when the skew is neutral and may be very high with low OI. With this type of funding, Kwenta ensures a fair deal for both sides of the trade. The skew on Kwenta frequently remains neutral, resulting in low risk for liquidity providers. This low risk should lead to future increases in OI caps and the addition of more assets without significant systemic risk. * If the imbalance is significant, funding changes quickly * If the imbalance is minor, funding changes slowly * Imbalance can be with negative funding due to a small amount of it Options ------- > Options are versatile financial products. These contracts involve a buyer and seller, where the buyer pays a premium for the rights granted by the contract. Call options allow the holder to buy the asset at a stated price within a specific timeframe. Put options, on the other hand, allow the holder to sell the asset at a stated price within a specific timeframe. Each call option has a bullish buyer and a bearish seller while put options have a bearish buyer and a bullish seller. - [Link](https://www.investopedia.com/terms/o/option.asp) Options are financial instruments that give the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price and date. In the DeFi space, options trading is facilitated by automated market maker (AMM) protocols (Lyra) or by Vaults (Opyn). Options trading has long been popular in traditional finance as a way to hedge against volatility or generate income. You may have heard some stories from WallStreetBets about Options trading on Tesla or GameStop contracts with huge gains or losses. And with the growth of DeFI, options trading has emerged as a new sector in the cryptocurrency field with a path starting as a Vaults and evolving into AMMs with the ability to make Delta Neutral Strategies AMM protocols use pricing curve algorithms to adjust prices based on the supply and demand of assets, providing liquidity for trading. Unlike traditional order book-based trading, AMMs are decentralized and don't rely on centralized entities to match buyers and sellers. However, options trading in DeFi is still in its early stages, with a limited number of platforms offering options trading on a select range of cryptocurrencies. Challenges remain, such as accurate pricing, minimizing impermanent loss risk for liquidity providers, and improving the user experience. Currently, the number of protocols offering options trading in DeFi is relatively small, and the transaction volume has yet to attract widespread participation from retail investors and institutions. Vaults vs. AMMs --------------- **The primary differences are trading efficiency, pricing accuracy, accessibility, and risk exposure.** Options AMMs, like Lyra, provide a more efficient trading environment compared to Opyn or Hegic by enabling traders to buy and sell options against a pool of liquidity exactly the same undercarriage as Perpetuals. This eliminates the need to wait for counterparties, resulting in faster execution times, lower fees, and increased accessibility. Additionally, options AMMs employ mathematical algorithms to ensure accurate pricing based on market conditions and liquidity, promoting fair market value. However, like liquidity providers on Pika or GNS, in Options AMMs LPs may also face the risk of impermanent loss due to price fluctuations of the underlying asset. While Lyra has implemented measures to mitigate this risk, such as dynamic fees and virtual balances, the impermanent loss remains a concern for some investors. On the other hand, options vaults, exemplified by Opyn and Hegic, offer different advantages and disadvantages. Investors can write options contracts in options vaults and earn premiums, making them appealing for generating additional income or hedging against market volatility. However, options vaults can be more complex and less flexible compared to AMMs. Additionally, the level of pricing accuracy in options vaults may not match AMMs. Le Finale' ---------- **I**n conclusion, perpetual contracts or options offer traders the ability to speculate on underlying assets with leverage while avoiding expiration dates and delivery risks. Funding plays a crucial role in balancing the demand between long and short positions. By this it opens the whole new market for Arbitragers and Delta Neutral Strategies. Each platform has its own distinctive features that have both sides, negative and positive with a different approaches to mitigate risks for LPs. Additionally, both sectors of options and perpetuals are still emerging and trying to beat CEXs, with new ways to offer different advantages in DeFi field. Overall, the DeFi space continues to evolve, with ongoing efforts to improve pricing accuracy, reduce risk, trade execusion time and enhance the user experience in trading. * * * Big thanks for helping with the article to Kwenta and Lyra team! _To learn more about Via Protocol, check out:_ * [Twitter](https://twitter.com/via_protocol) * [Discord](https://discord.com/invite/viaexchange) * [Docs](https://docs.via.exchange/product-docs/) **See you on the cross-chain and now on cross-chain staking, Via Protocol team.** [Subscribe](null) --- *Originally published on [Via Labs](https://paragraph.com/@viaexchange/perpetuals-and-options)*