A futures contract is a binding bilateral financial contract between two parties (buyer and seller). Both parties agree and are obligated to exchange an underlying asset at a set price on a predetermined future date (settlement date). On the settlement date, the two parties fulfill their obligation to buy/sell the underlying asset and incur profit/loss. In practice, most futures contracts are not signed bilaterally but through a trusted middleman such as an exchange i.e.
(1) buyer enters a long position against the exchange and
(2) seller enters the mirroring short position against the exchange.
This allows both the buyer and seller to then transfer their open positions to other parties at the prevailing futures price. In the presence of market arbitrageurs, futures price eventually converges to the spot price of the underlying asset on the settlement date. Furthermore, futures contract are often deployed with leverage - both buyer and seller can enter the full position by posting margin/collateral upfront. Should the loss exceed the maintenance margin requirement, a “margin call” occur and the losing position holder is required to post additional collateral, failure to do so would result in position liquidation.
A perpetual futures contract is a futures contract with no settlement date i.e. the buyer and seller cannot realize profit/loss based on contract settlement, but only through the transfer of their open positions to other parties (at the prevailing perpetual futures price). The lack of a settlement date means that perpetual futures price need to be anchored to the underlying spot price with a special mechanism: the funding rate mechanism:
When the perpetual futures price is above the spot price, traders holding long positions would pay a funding fee (= notional of position x funding rate, a rate proportional to the difference between perpetual futures price and spot price) to those holding short positions. This increases the costs of holding long positions and benefits of holding short positions. Conversely, when the perpetual futures price is below the spot price, traders holding short positions would pay a funding fee to those holding long positions, hence incentivizing traders to hold long positions instead of short positions.
Funding fees are usually calculated and transferred periodically (e.g. every hour) to ensure ongoing anchoring of the perpetual futures price to spot price.
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