I've been thinking for a while that in the next bull market, Perpetual-based DEX projects are likely to experience significant growth. There are predictions that if the cryptocurrency derivatives market fully matures, it could expand to a $10 trillion scale. However, compared to AI and GameFi, the concept of Perp is still generally harder to understand. So today, I want to carefully explain this field from the basics.

First, what exactly are derivatives? Simply put, they are mechanisms to lock in the price at a future point in time from now. Historically, they date back to 16th-century transactions between farmers and merchants. Farmers were worried about how much soybeans would sell for at harvest in autumn, and buyers couldn’t predict their procurement costs. So, they created forward contracts where both parties agree in advance on the price and quantity. For example, they might agree on trading 1,000 tons of soybeans at 100 yuan per ton on September 1. When that day comes, the contract is executed regardless of the market price. Whether the price has risen or fallen, both parties’ risks are fully fixed.

Applying this to financial markets, the essence becomes speculation on future price movements. You don’t need to actually hold the soybeans; if you think prices will rise, you can take the buyer side; if you think they will fall, you can take the seller side. In other words, you can profit whether prices go up or down.

Now, the difference between futures and spot. First, futures have expiration dates and become worthless after they expire. Spot, on the other hand, has no expiration. If you hold BTC spot, you can keep holding it forever unless you sell. Second, futures allow you to profit whether prices go up or down, but spot only profits when prices rise. Futures can be shorted (sold first, then bought back), but spot cannot. Also, futures are leveraged. If you trade a contract worth 1 million with 10x leverage, your margin is only 100k. But if you get liquidated, you lose the entire principal. Spot trading involves actual assets, so as long as Bitcoin doesn’t go to zero, you won’t lose everything.

In the crypto market, derivatives mainly come in three types. The first is traditional futures, contracts to buy or sell assets at a specific time and price. For example, buying a “10DEC2023 BTC” contract at $45,000 gives you the right to receive BTC at $45,000 on that day. But you’re buying a “contract,” not actual BTC.

The second is Perpetual futures, also called Perp. These are contracts without an expiration date, allowing indefinite holding. Because of this, their contract price stays very close to the spot price. The mechanism that keeps them aligned is the funding rate. If the funding rate is positive, the market is bullish; if negative, bearish. It reflects market sentiment.

The third is options. Unlike futures, options give you the right but not the obligation to buy or sell. A call option gives the right to buy at a specific price, a put option gives the right to sell. For example, if ETH is at $2000 and you buy a $2400 call, if ETH rises to $2500, you can buy at $2400 and profit. If your prediction is wrong, you only lose the premium paid.

Derivative trading involves greater risks than simply holding the underlying asset. Leverage especially increases danger. Since cryptocurrencies are inherently volatile, beginners should avoid this area. However, for professional traders, derivatives serve as complex trading strategies and hedging tools.

This is where Perp DEX projects come into focus. Unlike centralized exchanges (CEX), liquidity providers act as counterparties. Perp DEXs enable investors to execute perpetual swap trades. Combining leverage with market volatility creates both remarkable opportunities and risks.

Monitoring open positions can reveal market sentiment. Increasing long positions indicate bullishness; increasing short positions suggest bearishness. The funding rate links spot prices and perpetual futures prices; negative rates indicate bearish markets, positive rates indicate bullish markets.

Almost all Perp DEX protocols have governance tokens. These are similar to company shares; holding them allows you to earn a portion of platform revenue. There are also liquidity tokens, enabling individual investors to participate in market-making activities and earn fees.

Before Layer 2 solutions emerged, such trading was only possible on CEXs. But with the development of L2 networks like Arbitrum, the potential for Perp has greatly expanded. Now, most Perp DEXs operate on Layer 2 and are growing rapidly. Notable projects include GMX, Gains Network, Vela, MUX Protocol, Kwenta, and others.

Finally, a crucial warning. The crypto market is extremely risky. Derivative trading amplifies that risk even further. Always check your local laws and regulations, and practice thorough risk management. This article is for educational purposes only and does not constitute investment advice.