Understanding Perps: The Rise of Crypto's Most Popular Trading Instrument

Perpetual swaps, or 'perps', are a type of derivative contract that has revolutionized the crypto market. They allow traders to gain leveraged exposure to the price of assets like bitcoin without actually owning the asset. To comprehend perps, it's essential to understand their origins. In traditional finance, futures contracts are used to gain leveraged exposure to an asset, but these contracts have an expiry date, after which they must be rolled over into a new contract. However, in the early days of crypto, this practice created issues, including a persistent difference between the futures price and the spot price, known as basis. This confusion led to the development of perpetual swaps, which eliminate the expiry date and allow traders to hold positions for any duration. The perpetual swap price is kept in check by a funding rate mechanism, which incentivizes traders to push the price back towards the spot price. This mechanism has become the industry standard and is now used by all major derivatives exchanges. Perpetual swaps also offer high leverage, allowing traders to control large positions with relatively small amounts of capital. However, this leverage comes with significant risk, and exchanges use automated liquidation systems to manage this risk. Today, perpetual swaps are the primary venue for price discovery in crypto, with price movements often originating in perp markets before spreading to spot markets. The success of perpetual swaps has been so significant that regulators are now exploring their application to traditional assets, with the potential for perpetual swaps on equities to be listed on the CME.