What is a futures contract?
A futures contract is an agreement to buy or sell a commodity, currency, or other financial instrument at a predetermined price at a specified time in the future.
Unlike the traditional spot market, in the futures market, trades are not "settled" immediately, but rather two contracting parties trade a contract that specifies settlement at a future date. The futures market does not allow users to buy or sell digital goods or assets directly. Rather, users trade a contractual representation of these goods or assets, and the actual trading of the assets (or money) occurs in the future, when the contract is executed.
As a simple example, let's look at the case of a futures contract for a physical commodity, such as wheat or gold. In some traditional futures markets, these contracts are marked for delivery, meaning there is a physical delivery of the commodity. As a result, the gold or wheat must be stored and transported, resulting in additional costs (known as holding and transport costs). However, many futures markets now have cash settlement, which means only the cash equivalent value is settled (there is no physical exchange of goods).
In addition, the price of gold or wheat in the futures market may be different depending on how far the contract was settled. The larger the time gap, the higher the holding and transportation costs, the greater the uncertainty regarding potential future prices, and the larger the potential price gap between the spot market and the futures market.
Why do users trade futures?
Hedging and risk management: This was the main reason for the emergence of futures contracts.
Short-Term Exposure: Traders can bet on the performance of an asset even if the asset does not belong to them.
Leverage: Traders can enter into trades larger than their account balance
What is a perpetual futures contract?
A perpetual contract is a special type of futures contract, but unlike the traditional form of futures, it has no expiration date, so the user can hold the position as long as they want. Otherwise, perpetual contract trading is based on the underlying index price, and the index price consists of the average price of the asset, according to the major spot trading markets and their relative trading volume.
So, perpetual contracts, unlike traditional futures contracts, often trade at a price that is equivalent to or very similar to prices in the spot markets. The biggest difference between traditional futures contracts and perpetual contracts is the “settlement date” of traditional futures contracts.
What is initial carry trading?
The initial leverage trade is the minimum amount you must pay to open a leveraged trade. For example, you can buy 1000 BNB tokens with an initial leverage trade of 100 BNB (at 10x leverage). Therefore, the initial carry trade will be 10% of the total demand. The initial leverage trade is what backs your leveraged position, acting as collateral.
What is carry trading for maintenance?
Maintenance leverage trading is the minimum collateral amount you must hold to keep trades open. If your borrowing trading balance falls below this level, you will receive a borrowing request (asking you to add more funds to your account) or your account will be liquidated, and most cryptocurrency trading platforms will perform the latter.
In other words, the initial carry trade is the amount you commit to when you open a trade, and the maintenance carry trade refers to the minimum balance that must be maintained to keep trades open. Maintenance leverage trading is a dynamic value that changes according to the market price and your account balance (collateral).
What is filtering?
If the value of the security falls below the maintenance borrowing trading level, your futures account may be subject to liquidation. On Binance, liquidation occurs in different ways, according to the risk and leverage of each user (based on the collateral and their net exposure), the larger the total transaction, the higher the borrowing required.
The mechanism varies by market and trading platform, but Binance charges a nominal fee of 0.5% for Tier 1 liquidations (net exposure less than 500,000 USDT). If the account has any additional funds after liquidation, the rest of the funds are returned to the user, and if it has less than that, the user is declared bankrupt.
Note that when you liquidate your account, you will pay additional fees. To avoid this, you can either close your trades before the liquidation price is reached or add more funds to the escrow balance, which will cause the liquidation price to move away from the current market price.
What is the financing rate?
Financing is regular payments between buyers and sellers, at the current financing rate. When the funding rate is above zero (positive), traders who are long (contract buyers) must pay traders who are short (contract sellers). In contrast, negative financing rates mean shorts pay out to longs.
The financing rate is based on two components: the interest rate and the installment. On the Binance futures market, the interest rate is fixed at 0.03%, and premiums vary according to the price difference between the futures and spot markets. Binance does not charge any fees for funding rate transfers because they happen directly between users.
Therefore, when a perpetual futures contract is traded in installments (higher than in spot markets), longs must pay shorts because the funding rate is positive. Such a situation is expected to cause the price to fall, as longs close their positions, and new shorts are opened.
What is a fair price?
A fair price is an estimate of the true value of a contract (fair value) when compared to the actual trading price (last price). Calculating a fair price prevents unfair liquidations that may occur when the market is highly volatile.
Thus, while the index price is linked to the spot market price, the fair price represents the fair value of the perpetual futures contract. On Binance, the fair price is based on the index price and the funding rate, which is also an essential part of the “unrealized gains and losses” calculation.
What is profit and loss (PnL)?
PnL stands for profit and loss, which can be realized or unrealized. If you have open trades in the perpetual futures market, your profits and losses are unrealized, meaning they still change in response to market movements. When you close your trades, unrealized gains and losses turn into realized gains and losses (either partially or fully).
Since realized profits and losses refer to profits or losses that arise from closed trades, they do not have a direct relationship to the fair price, but only to the execution price of the orders. On the other hand, unrealized gains and losses are constantly changing, and are the main driver of liquidations. Therefore, a fair price is used to ensure that the calculation of unrealized gains and losses is accurate and fair.
What is an insurance fund?
An insurance fund is simply what prevents the balance of losing traders from falling below zero, while ensuring that winning traders get their profits.
To illustrate this, let's say for example that Alice has $2,000 in her Binance Futures account, which is used to open a buy trade for 10x BNB at $20 per coin. Note that Alice is buying contracts from another trader and not from Binance, therefore, on the other side of the trade we have Bob who has a sell position of the same size.
Due to the 10x leverage, Alice now has a position worth 100 BNB (equal to $20,000), with a collateral of $2,000. But if the price of BNB drops from $20 to $18, Alice's trade may be automatically closed. This means that her assets will be liquidated and she will lose her entire $2,000 guarantee.
If for any reason the system cannot close its trades on time and the market price falls further, an insurance fund will be activated to cover those losses until the trades are closed. This won't change much for Alice, because her account has been liquidated and her balance is zero, but it ensures that Bob can get his winnings. Without the insurance fund, Alice's balance would not only drop from $2,000 to zero, but it could also become negative.
In practice, her put trade will most likely be closed before this happens because her maintenance carry trade will be less than the minimum required. The liquidation fee goes directly to the insurance fund, and any remaining funds go back to the users.
Thus, an insurance fund is a mechanism designed to use collateral obtained from liquidated traders to cover losses in bankrupt accounts. Under normal market conditions, the insurance fund balance is expected to continually increase as user accounts are liquidated.
Hence, the size of the insurance fund increases larger when users liquidate their accounts before their trades reach a break-even point or negative value. But in some rare cases, the system may not be able to close all trades, and the insurance fund will be used to cover possible losses. Although this is uncommon, it can occur during periods of high volatility or low liquidity in the market.
What is auto upload cancellation?
Automatic de-leveraging refers to a method of counterparty liquidation that only occurs if the insurance fund stops operating (during specific situations). Although this event is unlikely, it requires winning traders to contribute a portion of their profits to cover the losses of losing traders. Unfortunately, due to the volatility of cryptocurrency markets and the high leverage offered to clients, this possibility cannot be completely avoided.
In other words, counterparty liquidation is the last step taken when the insurance fund is unable to cover all bankrupt trades. It is usually the trades with the highest profits (and highest leverage) that contribute the most. Binance uses an indicator that tells users their rank in the auto-upload queue.
In the Binance futures market, the system takes every possible step to avoid automatic de-leveraging and has several features to reduce its impact. If this happens, the counterparty is liquidated without any market fees, notification is immediately sent to affected traders, and users are free to re-enter trades at any time.