Understanding Perps: The Most Traded Financial Instrument in Crypto

Perpetual swaps, or 'perps', are a type of trading instrument that has revolutionized the crypto market. They allow traders to have leveraged exposure to the price of assets like bitcoin without actually owning them. Despite their popularity, the mechanics behind perps are not well understood. To grasp the concept of perps, it's essential to look at their origins. In traditional finance, leveraged exposure to an asset is typically achieved through futures contracts, which have a set expiration date. However, this approach created problems in the crypto market, where futures traded at a premium to the spot price, causing confusion among traders. The solution came in the form of perpetual swaps, which eliminated the expiration date altogether. This innovation allowed traders to hold positions indefinitely, without the need to roll over contracts. The perpetual swap price is kept in check by a funding rate mechanism, which ensures that the price remains close to the spot price of the underlying asset. This mechanism involves the exchange of payments between traders on opposite sides of the market, with the rate being calculated based on the deviation from the spot price. The use of leverage is another key aspect of perpetual swaps, allowing traders to control large positions with relatively small amounts of capital. However, this also increases the risk of significant losses, 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.