Cryptocurrency perpetual contracts are known for their high risks because users can use 100X leverage to obtain greater returns and at the same time need to bear higher risks. Therefore, in order to minimize risks, most perpetual contract services adopt an 'index mechanism'.
What is Index?
Currently, there are many spot crypto exchanges in the market, and the index mechanism of perpetual contracts generally uses price data from multiple exchanges with the top trading volume and calculates and weights them to get their own index prices.
Perpetual contracts operated by different exchanges have different index components and weight components used in their index mechanisms. DueDEX BTCUSDT Index tracks the USDT price of Bitcoins in spot markets, which updates every 5 seconds. Currently, it is made up of the latest prices from Binance, Okex, Huobi Global, and Hitbtc in which each weighs 25%.
What is the use of index prices?
The index price is a key indicator of the index mechanism. Index price refers to the price calculated based on the spot prices of multiple leading exchanges and weighted in different proportions.
Index prices are used to represent the reasonable prices of mainstream cryptocurrencies such as BTC, ETH, LTC, EOS, and USDT in the global spot market, which can significantly represent the accurate current status of the market.
At the same time, the index price is also a key indicator for calculating unrealized profit and loss and determining position risk in perpetual contracts.
In other words, the liquidation is related to the index price rather than the market price. Its relevance is reflected in the fact that it is used as a reference for planning unrealized profit and loss, and unrealized profit and loss is related to the total amount of available balance in the account. Whether the available balance of the account can overweigh the maintenance margin becomes the key to whether the position is liquidated.
How does the index mechanism deal with abnormal spot prices?
In order to ensure that the spot index mechanism can reasonably reflect the fair spot market price of each trading currency, most exchanges will choose the currencies of more than 3 mainstream exchanges as the index weight components.
The index price will also change rapidly following the latest spot trading price of each exchange in the index component. In the event of an abnormal situation, the index mechanism of the perpetual contract will automatically adjust the abnormal data source in the component.
In other words, when an abnormality occurs in the spot market price of a certain exchange in the index component then the abnormal data source will be removed from the index component by the platform. At the same time, the platform will automatically adjust the weight of other data sources based on native algorism.
In this way, when the price of a single exchange deviates significantly, the abnormal situation handling mechanism can ensure that the index fluctuates within the normal range.
The advantages of the index mechanism
In the cryptocurrency market, there are always some speculators trying to use loopholes in the platform's price mechanism to disrupt market order and profit from it.
This kind of artificially lowering or raising prices will cause abnormal fluctuations in market prices, thereby damaging the interests of many ordinary players.
The perpetual contract effectively avoids this. The transaction price of perpetual contracts is the market price that anchored to the index price, which is used as the calculation price of profit and loss, rather than the market price.
Unless someone can manipulate the prices of multiple exchanges and pin on multiple top exchanges at the same time to affect the index price, it will be very difficult to liquidate positions.
At present, there are at least two exchanges where the index price of perpetual contracts is anchored. As a result, it is much more difficult for speculators to manipulate the market by pinning. That is to say, it is almost impossible to manipulate it.
As mentioned above, DueDEX BTCUSDT Index tracks the USDT price of Bitcoins in Binance, Okex, Huobi Global, and Hitbtc and each weighs 25%. While BTCUSD Index tracks the USD price of Bitcoin from Bitstamp, Coinbase Pro, and Kraken, with the same weight.
This composite index means it’s a price collection from several mainstream exchanges. This index should represent the overall average price level and should have ruled out malicious market manipulation.