Understanding Perpetual Swaps: The Most Traded Financial Instrument in Crypto

Perpetual swaps, or 'perps', have revolutionized the crypto trading landscape, offering a unique way to gain leveraged exposure to assets like bitcoin without owning them. To grasp the concept of perps, it's essential to understand their origins. In traditional finance, futures contracts provide leveraged exposure, but they come with an expiry date, which can lead to issues like basis and forced position closures. The launch of perpetual swaps on BitMEX in 2016 addressed these problems by eliminating the expiry date, allowing traders to hold positions indefinitely. A key mechanism, known as the funding rate, ensures the contract price remains anchored to the spot price of the underlying asset. Every eight hours, a payment is exchanged between traders on opposite sides of the market, based on the deviation from the spot price. This self-correcting equilibrium helps maintain a stable market. Leverage is another defining feature of perpetual swaps, allowing traders to control large positions with minimal capital. However, this also increases the risk, which is managed through automated liquidation systems. Perpetual swaps have become the primary venue for price discovery in crypto, with regulators now exploring their application to traditional assets. The structure of perpetual swaps has proven durable, and their influence extends beyond the crypto market, with potential applications in equities and other assets.