A perpetual swap (future) is an innovation in the cryptocurrency markets that was pioneered by the exchange BitMEX. Other exchanges, including Binance and FTX, have adopted this structure since its creation—making it a common part of life for traders on many crypto platforms today. Unlike futures contracts, perpetual swaps can be held indefinitely without rolling over the contract as it reaches maturity. By the end of 2021, the volume and popularity of perpetual swaps had increased dramatically, with volume exceeding $56.8 billion—more than 3.6 times the volume reported for all derivatives combined in 2020. In addition, the total volume of perpetual swaps was more than half (50.4%) of all trading on CeFi.
This extreme increase in popularity revealed certain drawbacks: perpetual swaps are vulnerable to market manipulation, and the actual cost of trading may become extremely high. Over a longer-term horizon, funding fees can start biting into your profits, as high as 300% annualized! Traditional futures, also known as expirable futures, are a much better option, considering cost control and Contango is in the forefront of expirable futures in DeFi. It is challenging the status quo in the crypto market—with plans to offer expirable contracts that look more like traditional futures traded on exchanges such as CME.
Expirable vs Perpetual futures
Futures are types of derivative contracts that investors use to buy or sell assets at a specified price and time in the future. Traditional vs. perpetual futures are differentiated primarily by the element of expiration. Traditional futures have an expiration date, but perpetual futures do not. The expiration of a futures contract leads to physical delivery. When perpetual futures are used, the cash settlement replaces that mechanism.
This difference between the two contracts leads to another: the funding rate. Since a perpetual futures contract is a derivative of its underlying asset, the price of such a contract may deviate from that asset's true value. For example, during a bear market, the price of a BTC perpetual contract can be lower than the spot market price of BTC—because traders' negative sentiment pushes them to speculate that prices will continue to fall. In the absence of a contract expiry time, prices must be adjusted so that they reflect market conditions. The funding rate mechanism corrects for price differences by levying fees on traders who hold long and short positions at certain intervals according to exchange rules. If the funding rate is negative, shorts pay longs and vice versa.
Why expirable futures?
Expirable futures were first introduced in 1697 to offer a way of stabilizing income and offsetting risk, id est hedging. They were also the first derivative product. Futures contracts were originally used to mitigate the risk of price or exchange rate movements by allowing parties to fix prices or rates in advance for future transactions. This proved to be useful when a party expects to receive payment in foreign currency, but would prefer to guard it against an unfavorable movement of the currency by converting part of its income into that currency before receiving payment.
Futures contracts, however, can also be used for speculation. For example, a trader who predicts that the price of an asset will move in a particular direction can contract to buy or sell it at some future time—if that prediction is correct and no other changes are made between now and then (such as dramatic fluctuations in supply), this could yield a profit. If the speculator is able to profit, then he or she has presumably helped stabilize prices by buying commodities when they are cheap and selling them when they're expensive.
Although perpetual futures can also offer hedging and speculation, their highly fluctuating pricing makes them a less cost-effective alternative.
What is Contango Exchange?
According to the Contango website:
"Contango is a unique decentralized exchange offering expirable futures without order books or liquidity pools. When a trader opens a position, the protocol borrows on the fixed-rate market, swaps on the spot market, then lends back on the fixed-rate market. Contango offers physical delivery and a minimal price impact for larger trades."
By tapping into the liquidity pools found in underlying fixed-rate markets, Contango is able to offer order sizes and price impact comparable to major centralized exchanges. For crypto traders, there may be an arbitrage opportunity between Contango's own market and major exchanges like Binance.
Contango main features include:
Linear and inverse contracts - Choose between linear and inverse contracts, set an expiry date, choose your leverage ratio—and stop worrying about unpredictable funding rates.
Synthetic futures - Contango borrows on the fixed-rate market, swaps on the spot market, and lends back on the fixed rate market to replicate the cash flow of a futures position.
Minimal price impact- Contango doesn't rely on a separate liquidity pool. Instead, it harnesses the deep liquidity pools of underlying protocols to offer minimal price impact regardless of trade size.
DeFi composability- Every position is tokenized as an NFT enabling other projects to easily build on top of Contango.
Physical delivery- When the position expires, Contango delivers the asset at its purchase price to you—eliminating risks associated with index price manipulation.
What are the risks of using Contango?
Admirably, Contango openly discusses its own limitations, opening doors for developers and other involved parties to improve future products by making improvements based on what did not work in previous iterations.
To help us understand why there are risks involved in using Contango, we should go over some key features of the protocol:
“Contango prices futures via spot and fixed-rate protocols, so it’s reliant on the liquidity of these markets (Uniswap, Yield, Notional). The long-term vision is to aggregate as many markets as possible to offer the best liquidity — read: price — for expirable futures in DeFi.
Contango doesn’t have an order book, nor liquidity pools, which means there’s no liquidity held on protocol (no TVL).
Even the trader’s collateral is put to work for better capital efficiency on the underlying protocols so, again, no liquidity is locked within Contango.
Liquidations are not carried out on Contango, but on the underlying protocols.
At maturity Contango offers physical delivery to eliminate risks of price manipulation.”
Therefore, when using Contango, a trader must consider the following risks:
“Liquidity risk, i.e. the possibility of thin liquidity on underlying markets, especially when closing a position.
Market risk, i.e. sudden movements in price that can result in potential liquidations.
Smart contract risk, i.e. the risk of using protocols (i.e. lines of code) that can be hacked and exploited. Contango is currently undergoing multiple security audits.”
What is the potential market reach?
DeFi refers to the idea that traditional financial instruments can be made to work in a decentralized way—but most such instruments currently offered by the cryptocurrency industry are still centralized.
The Block reports that the spot trade volume between DEXs and CEXs rose to almost a quarter of all trades, while futures contracts made up only 2.6% of overall transactions. An exciting development considering that between 2020 and 2021, the volume of perpetuals increased almost 6x—surpassing spot trading volume by a significant margin.The increase was also the main factor leading to a rise in total trading volume from 33.47 trillion US dollars in 2020 to 112.94 by 2021, with most of this growth occurring at CEX's.
According to Tokeninsight, the volume of expirable futures was 6.6 US trillion in 2021—when only CEX's offered these products. Therefore, we can attribute all of this volume directly to CEX exchanges. In estimating the potential market reach that Contango Exchange will have, there are three approaches that could be used:
the conservative estimate of the DEX/CEX ratio is 2.61%, which equates to 17.23 US billion in yearly volume;
the average of the two rates, namely 14.065 percent and translating into 92.83 US billion in yearly volume—is a reasonable approach as Spot/Futures ratio is close to 1;
and the aggressive approach estimates a 25.52% ratio of DEX/CEX, which would amount to 1.68 US trillion in yearly volume.
It is important to note that these estimations were made from the peaks, but if we had used rolling 12-month averages, our estimates would be approximately half as high—still very good.
Tokenomics
Breakdown of the Token Allocation:
Breakdown of the raises:
ROADMAP
Contango Team
Kamel Aouane, Co-founder & CEO
During his time at McGill, Kamel created an automated trading software start-up where he was able to negotiate funding and resources from FIN-XO Securities Inc. in order to make it a reality. Afterward, he became a product developer for The French National Centre for Scientific Research. He co-developed an innovative approach to convert heat into electricity—and then patented and published his findings. After these experiences, Kamel moved into the field of business management consultancy where he served at Sapient Global Markets, EF6 Entrepreneur and OTCFin - where he also served as a senior developer. In Adaptive Financial Consulting, he served for 4 years and 4 months. It was in this company that he first encountered the cryptocurrency industry—a career path that eventually led him to found his own project: Contango Exchange.
Bruno Bonanno, Co-Founder
Bruno has more than 20 years of professional experience. After the initial 7 years and 5 months freelancing as a Level 1 and 2 technician, he joined well-established companies to gain more experience—before deciding on his current line of work. First, he became a Java Software Engineer at Visa. Then he held the position of Head of IT & Software Development department while also teaching computer science classes as a teaching assistant. Bruno has worked for or with a number of well-known companies, such as the CME Group (which owns the Chicago Mercantile Exchange), Lloyds Banking Group and IG Group. Before co-founding Contango Exchange he spent time working with River Plate Consultancy Ltd., a software engineering consultancy in London specializing in risk management
Egill Hreinsson, Co-Founder
Egill's professional experience may be short, but good ideas can come at any given time. He started his career as a front-end developer and later on became a back-end developer for Adaptive Financial Consulting. After working for only two years, it appears that he came into contact with Kamel—which led to co-founding Contango Exchange. At the same time, though still a part of Contango Exchange full-time, he is also a Software Developer for Gangverk: an established software consultancy owned by seasoned professionals.
Concluding Remarks
Contango, born in the summer of 2021 at Hackmoney, is building the first open-source DEX to offer expirable futures without an order book or liquidity pools. The firm raised $4 million in a seed round, at a $45 million valuation, led by ParaFi and including Coinbase Ventures, Spartan Group, Amber Group and many other Tier 1 investment firms. The beta version was already launched this summer. Although Contango has initially limited its appeal to institutional investors, the company plans to expand into retail markets through apps built on top of the protocol. Since there are no other players in the DeFi field of expirable futures, Contango Exchange is a sure bet for success.
Disclaimer
All content and information provided here and on our website is for general information and educational purposes only. We make no warranties of any kind in relation to our content and services, including but not limited to accuracy, security and updates. No part of the content and services that we provide constitutes financial advice, legal advice or any other form of advice meant for your specific reliance for any purpose. Any use or reliance on our content and services is solely at your own risk and discretion. You should conduct your own research, review, analyze and verify our content and services before relying on or using them and consult a licensed financial planner.
Links
References
https://www.coindesk.com/markets/2022/07/14/dex-contango-pushes-retro-alternative-to-perps-with-expirable-futures/
https://image.tokeninsight.com/levelPdf/TokenInsight_2021_Yearly_Crypto_Trading_Industry_Report_compressed.pdf
https://docs.contango.exchange/basics/why-expirable-futures
https://medium.com/coinflex-official/physical-delivery-vs-cash-settlement-adoption-vs-market-manipulation-86e8cbd48837
https://hub.accointing.com/crypto-basics/crypto-metrics/traditional-futures-vs-perpetual-futures
https://en.wikipedia.org/wiki/Futures_contract
https://www.bullionvault.com/guide/gold/Gold-futures
https://www.bullionvault.com/guide/gold/Gold-futures https://docs.contango.exchange/basics/what-is-contango
https://www.bullionvault.com/guide/gold/Gold-futures
https://docs.contango.exchange/basics/what-is-contango