Understanding Perpetual Derivatives Protocols: A Primer for Web3 Security

Perpetual derivatives have become a cornerstone of decentralized finance. Since the launch of Perpetual Swaps by BitMEX in 2016, these financial instruments have matured significantly, carving out a unique niche in the on-chain ecosystem.

According to data from The Block, decentralized futures trading volume has reached around 7% of CEX volumes, a sign that the DeFi derivatives space is gaining traction. But as this market grows, so does its complexity and the surface area for potential vulnerabilities.

In this guide, we unravel the architecture, liquidity models, and common attack vectors of perpetual derivatives protocols, starting with the basics.

Key Fundamentals of Perpetual Derivatives

What Are Perpetuals?

Perpetual contracts are futures without expiry. Traders use them to speculate on asset prices—long if they anticipate a price rise, or short if they expect a drop.

Leverage

Leverage lets users open positions larger than their initial capital. While this increases potential gains, it also amplifies risk, particularly if the market moves unfavorably.

Liquidity Providers (LPs) & Pools

Liquidity in perpetuals comes from LPs who earn interest (APY) in return for lending their capital. This liquidity is stored in smart contract pools that fund traders' leveraged positions.

Open Interest (OI)

OI is the cumulative notional value of all active positions. Protocols often cap OI based on available liquidity, ensuring solvency.

Funding Rates, Orderbooks & Market Makers

Funding rates help align perpetual contract prices with spot markets. When one side of the market (long or short) becomes dominant, funding flows to the other side as an incentive to balance positions.

Market makers and orderbooks play a crucial role depending on the protocol's design. Some use automated market makers (AMMs), while others rely on Central Limit Orderbooks (CLOBs) for deeper liquidity and better price discovery.

Liquidation Mechanics: A Risk-Aware Example

Imagine opening a long ETH position with $1000 collateral and 5x leverage. The position size becomes $5000. If the market drops significantly, your position faces liquidation. The liquidation price is calculated using variables like leverage, fees, and margin—miss this math, and you're likely to lose your funds.