Uncovering Perps: The Crypto Trading Instrument Everyone's Talking About

Perpetual swaps, or 'perps', are the go-to trading instrument in the crypto market, facilitating massive volumes. But what exactly are they? To grasp the concept of perps, it's essential to understand their origins. In traditional finance, futures contracts provide leveraged exposure to assets, but they come with an expiry date. When this date arrives, the contract settles, and traders must roll over their positions to maintain exposure. However, this approach created issues in the early days of crypto. Futures traded at a premium to the spot price of bitcoin, causing confusion among retail traders. Furthermore, contract expirations led to unwanted position closures. BitMEX, a pioneering derivatives exchange, attempted to address these problems by shortening contract durations, but this didn't suffice. The perpetual swap, developed by BitMEX co-founder Ben Delo, revolutionized the landscape by eliminating the expiry date. This innovative contract tracks the asset price indefinitely, allowing traders to hold positions for any duration. A key challenge arose: without an expiry date, the contract price might deviate from the spot price. To counter this, BitMEX introduced a funding rate mechanism, where traders on opposite sides of the market exchange payments every eight hours. This self-correcting equilibrium has become the industry standard. The funding rate is calculated based on the deviation between the perpetual swap price and the spot price over the preceding eight-hour window. When the perpetual swap trades above the spot price, long positions are charged a funding rate, making it expensive to hold, which in turn pulls the price back toward spot. Market makers accelerate this process by shorting the perpetual swap and buying spot, capturing the difference as profit. Leverage is another defining feature of perpetual swaps. Exchanges allow traders to control large positions with limited capital, but this creates risk. To mitigate this, perpetual swap platforms employ automated liquidation systems, which close positions before they can incur losses. The speed and reliability of these systems have become a key competitive differentiator. Perpetual swaps have evolved into the primary venue for price discovery in crypto, with bitcoin price movements often originating in perp markets before spreading to spot. The structure developed by Delo has proven durable, and regulators are now exploring its application to traditional assets.