Understanding Perps: The Most Traded Financial Instrument in Crypto

Perpetual swaps, or 'perps', have revolutionized the crypto market by providing a unique trading instrument that combines the benefits of futures contracts with the flexibility of spot trading. By eliminating the expiry date, perps allow traders to hold positions for extended periods without the need for rolling contracts. This innovation, developed by Ben Delo and launched on BitMEX in 2016, has solved the persistent problems associated with traditional futures contracts in crypto. The key to perps' success lies in their self-correcting mechanism, which uses a funding rate to maintain equilibrium between the contract price and the spot price of the underlying asset. Every eight hours, a payment is exchanged between traders on opposite sides of the market, with the rate calculated based on the deviation from spot. This mechanism, now widely adopted by major derivatives exchanges, ensures that the contract price remains anchored to the spot price. Perps also offer high leverage, allowing traders to control large positions with minimal capital. However, this leverage comes with significant risk, and automated liquidation systems are used to manage this risk and protect the exchange from potential losses. Today, perps are the primary venue for price discovery in crypto, with price movements often originating in perp markets before spreading to spot. The success of perps has even caught the attention of regulators, who are now exploring their application to traditional assets.