Understanding Perpetual Swaps: The Dominant Crypto Trading Instrument

Perpetual swaps, or 'perps', process an estimated $40-50 trillion in annual volume, surpassing spot trading. They allow professional traders, hedge funds, and speculators to gain leveraged exposure to bitcoin and other assets without holding the underlying asset. Despite their popularity, the mechanics of perps are not well understood. To comprehend perps, it's essential to understand their predecessors, traditional futures contracts, which have an expiry date. In crypto's early days, this created issues, such as basis and forced position closures. BitMEX addressed this by introducing perpetual swaps, which have no expiry date and track asset prices indefinitely. A funding rate mechanism ensures the contract price stays close to the spot price. Every eight hours, traders on opposite sides of the market exchange payments, with the rate calculated based on the deviation from the spot price. This self-correcting equilibrium reduces demand and pulls the price back toward spot when longs are charged a high funding rate. Leverage is another key feature of perps, allowing traders to control larger positions with deposited capital. Automated liquidation systems manage risk by closing positions before losses exceed the deposited margin. Perpetual swaps have become the primary venue for price discovery in crypto, with regulators exploring their application to traditional assets.