Uncovering Perps: The Ultimate Guide to Crypto's Most Popular Trading Instrument

Perpetual swaps, or 'perps', are the backbone of the crypto market, facilitating an estimated $40 trillion to $50 trillion in annual trading volume. These financial instruments offer professional traders, hedge funds, and retail investors leveraged exposure to assets like bitcoin, without the need for ownership. Despite their widespread adoption, the underlying mechanics of perps remain shrouded in mystery. To grasp the concept of perps, it's essential to understand their predecessors. Traditional finance typically provides leveraged exposure through futures contracts, which expire on a specific date. However, this approach created persistent issues in the crypto space, including basis and forced contract expirations. BitMEX addressed these problems by introducing perpetual swaps, which eliminated expiry dates and enabled traders to maintain positions indefinitely. This innovation was made possible by a funding rate mechanism, where traders on opposite sides of the market exchange payments every eight hours, ensuring the contract price remains anchored to the underlying asset's spot price. The funding rate is calculated based on the deviation between the perpetual swap price and the spot price over the preceding eight-hour window. This self-correcting equilibrium is now an industry standard, used by major derivatives exchanges worldwide. Another key feature of perpetual swaps is leverage, allowing traders to control large positions with minimal capital. To mitigate the risks associated with high leverage, exchanges employ automated liquidation systems, which close positions before they can incur significant losses. Perpetual swaps have become the primary venue for price discovery in crypto, with price movements often originating in perp markets before spreading to spot markets. The success of perps has even caught the attention of regulators, who are now exploring their application to traditional assets, with the potential for perpetual swaps on equities to be listed on the CME.