Understanding Perps: The Hottest Crypto Trading Instrument

Perpetual swaps, also known as perps, have revolutionized the crypto market by providing a unique trading instrument that allows for leveraged exposure to asset prices without owning the underlying asset. With estimated annual trading volumes of $40 trillion to $50 trillion, perps have surpassed spot trading and become the go-to product for professional traders, hedge funds, and retail speculators. To comprehend perps, it's essential to understand their origins and the problems they solved in traditional finance. In the past, futures contracts were used to gain leveraged exposure to assets, but they had limitations, such as expiry dates and basis issues, which confused retail traders. The launch of perps by BitMEX in 2016 eliminated these issues by introducing a derivative contract that tracks asset prices indefinitely, without an expiry date or settlement. This innovation created a structural challenge, which was addressed through a funding rate mechanism that exchanges payments between traders every eight hours, based on the deviation between the perpetual swap price and the spot price. This self-correcting mechanism has become the industry standard. Perps also offer leverage, allowing traders to control larger positions with lower capital, but this comes with risks, which are managed through automated liquidation systems. Today, perps are the primary venue for price discovery in crypto, with regulators exploring their application to traditional assets. The success of perps has proven that they are a durable and essential financial product, with the potential to transform traditional markets.