In the previous episode, we introduced liquidity, liquidity pools and liquidity providers. A lot of liquid! Today, we’re going to build upon that knowledge and look at some different applications of liquidity pools.

Jupiter Liquidity Pool (JLP)

Among many things, Jupiter runs a perpetual futures (perps) exchange.

Before discussing JLP, here’s a quick recap on perpetual futures and leverage.

Futures

A future is a common type of derivative, that’s to say it derives its value from an underlying asset.

It’s an agreement to make a trade in the future. For example:

• I’ll purchase 10kg of apples, in one month, for $100.

Therefore the future’s price will fluctuate depending on the perceived future price of apples.

As the end of the month nears, the future’s price converges with the market price of apples, and the trade settles.

Perpetual Futures

A perpetual future is similar, except it has no expiry date, so the trade can be held open perpetually.

But how do you ensure that a perp tracks the market price, if it never settles?

A funding rate, which is a small fee, is paid to one side of the market by the other. For example:

• If the perp is trading at a premium to the spot price, which tends to occur during bullish market sentiment, then the funding rate will be positive.
• As a result, those expecting upside (longs) will pay those expecting downside (shorts) a small fee.
• This fee slightly discourages those with a long position, and slightly incentivises traders to go short, as they will receive a tiny payment.

This eliminates the premium, ensuring that the perp tracks the underlying’s market price.

Leverage:

Leverage allows you to trade larger positions than your initial capital by borrowing funds.

For e.g. using 10x leverage, you can open a $10,000 position with only $1,000 of your own capital.

This would be a 10:1 leverage ratio.

Let's look at an example:

1. You open a $10,000 long using $1,000, this is 10x leverage.
2. If the asset increases by 10%, your position is now worth $11,000, resulting in $1,000 profit, and a 100% ROI.
3. Conversely if the asset falls by 10%, your position is now worth $9,000, netting a $1,000 loss and thus liquidation occurs.

Essentially, leverage magnifies profits and losses.

JLP