It was during a fateful hike in Hong Kong in 2015 that the concept of the perpetual swap, also known as a perpetual future or 'perp', was conceived. Ben Delo, BitMEX's co-founder and a skilled mathematician, was discussing a pressing issue with his friend Bavik, a derivatives trader. The problem revolved around finding a solution to the persistent complaints from customers whose positions were being closed without warning, despite their desire for a product that offered the benefits of spot trading but with the leverage only a derivatives exchange could provide.
Delo posed a question to Bavik: 'What if a future never expired?' Bavik's immediate response was that, mathematically, it would be worth infinity. While technically correct, as a futures contract's value is partly derived from its time to expiry and the cost of maintaining the position, removing the expiry date would result in an indefinitely compounding carrying cost, thereby making the theoretical value infinite. Bavik then suggested charging traders the bitcoin overnight rate, similar to how LIBOR is used in traditional finance, as a potential solution.
However, there was an issue - the bitcoin overnight rate did not exist at the time. Undeterred, Delo decided to create it, laying the groundwork for one of the most significant financial products of the 21st century. The Early Days of BitMEX To understand the impact of the perpetual swap, it's essential to grasp what BitMEX aimed to achieve before it became the world's most liquid bitcoin market.
Founded in 2014 by Delo and Arthur Hayes, the exchange initially targeted institutional hedgers, offering a professional infrastructure for bitcoin miners and payment companies to manage their exposure. Hayes had previously worked at Deutsche Bank, while Delo had spent years developing high-frequency trading systems at JP Morgan. The duo built BitMEX to resemble a Bloomberg terminal, utilizing Reuters instruction codes. However, the institutions they had hoped to attract never materialized.
Instead, the exchange was inundated with sophisticated retail traders seeking to speculate with high leverage. BitMEX adapted, introducing 100x leverage by Halloween 2015, made possible by Delo's real-time margining system. The perpetual swap was born out of the difficulties faced by BitMEX in its early days. The exchange had experimented with various futures contracts, including quarterly, monthly, weekly, 48-hour, and even 24-hour contracts.
Nevertheless, customers continued to express frustration with positions being closed without warning, prompting Delo to revisit the concept of a future that never expired. The Funding Rate Mechanism The perpetual swap launched in May 2016, featuring a straightforward core mechanic: a futures contract with no expiry date, anchored to the spot price via a daily funding rate. Longs paid shorts, or vice versa, depending on whether the swap was trading above or below spot. Initially, the funding rate was derived from third-party lending markets, primarily Bitfinex.
However, as bitcoin's price rose in 2016 and 2017, the demand for long exposure on BitMEX overwhelmed the funding mechanism. The swap began trading at a persistent premium to spot, causing the contract price to drift away from the actual bitcoin price. Delo realized that the interest rate being imported from Bitfinex was insufficient to reflect the conditions on BitMEX itself.
To address this issue, Delo introduced a dynamic funding rate, which looked inward at how the swap was trading rather than relying on external lending markets. The exchange began measuring the gap between the swap and spot prices over an eight-hour window, treating this gap as an implied basis, and back-calculating the annualized rate from it. This rate would then be charged at the end of the next eight-hour window, providing market makers with notice of the calculation and allowing them to adjust their positions accordingly.
The Perpetual Swap's Impact By 2017, BitMEX had become the most liquid bitcoin market globally, processing $3-4 billion in daily transactions, with the perpetual swap at its core. The product's design concentrated liquidity, allowing traders to consolidate their positions into a single instrument.
Competitors took notice, with some exchanges copying the perpetual swap, while others developed their own versions based on the funding rate architecture that Delo had pioneered. Today, the perpetual swap is a staple of the crypto derivatives market, with an estimated $40-50 trillion in annual turnover.
Delo's innovative product has attracted the attention of traditional finance regulators, with the CFTC reportedly making room for perpetual swaps under its framework. The CME may also list them on equities in the future, marking a significant milestone in the product's evolution. For Delo, the perpetual swap's success is a testament to the power of innovation and the importance of listening to customers.
As traditional finance continues to embrace this revolutionary trading concept, Delo remains optimistic about its potential to shape the future of financial markets.