Understanding Perpetual Swaps: The Most Traded Crypto Instrument

Perpetual swaps, or 'perps,' are a type of trading instrument that has revolutionized the crypto market. They enable traders to gain leveraged exposure to assets like bitcoin without actually owning them. Despite their widespread use, the inner workings of perps remain somewhat mysterious. To grasp the concept of perps, it's helpful to understand the traditional finance instruments that preceded them. In the past, traders relied on futures contracts to gain leveraged exposure to assets. However, these contracts had expiry dates, which led to issues like basis and forced position closures. The introduction of perps eliminated these problems by creating a derivative contract that tracks the asset price indefinitely. The key to perps is the funding rate mechanism, which ensures the contract price stays close to the spot price. Every eight hours, traders on opposite sides of the market exchange payments, with the rate calculated based on the deviation from the spot price. This self-correcting mechanism has become the industry standard. Perps also offer leverage, allowing traders to control large positions with minimal capital. To manage risk, exchanges use automated liquidation systems to close positions before they incur losses. Today, perps are the primary venue for price discovery in crypto, with regulators exploring their application to traditional assets. The structure of perps has proven durable, and they have become one of the most traded financial products globally.