Perpetual Futures: Funding, Pricing Models, Margin, and Liquidation

Summary

The document explains perpetual swaps through four equivalent models: a feedback mechanism that uses funding to pull the contract toward an external index, a transfer of profit and loss with interest-like payments, a swap of borrowing costs on the underlying asset and cash, and a sequence resembling a short-dated future. In the simplified exchange model, funding changes direction with the gap between mark and index prices. The examples show how that payment can offset exposure when the contract trades away from the underlying asset’s price.

It also explains margin accounting, liquidation thresholds, and the role of an insurance fund when losses exceed posted collateral. The models make assumptions about funding being paid, participant solvency, and interest rates; actual exchanges can use different designs, and the author explicitly simplifies one venue’s implementation. The discussion is conceptual rather than a test of returns or a full treatment of basis risk, fees, liquidity, or exchange-specific rules, so it should not be read as a complete pricing or risk model.

Key ideas

• Funding payments are designed to encourage convergence between a perp’s mark price and the underlying index.
• A perp can be understood as a cash-settled position that periodically transfers gains and losses between traders.
• The funding mechanism can also be modeled as net borrowing costs on cash and the underlying asset.
• Funding and exposure can make a perp resemble a short-dated future under simplifying assumptions.
• Margin and liquidations limit counterparty losses, while an insurance fund may cover a shortfall.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.