Understanding Perpetual Swaps: The Most Traded Financial Product in Crypto

Perpetual swaps, also known as 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 underlying asset. To comprehend perps, it's essential to understand their origins. In traditional finance, traders typically use futures contracts to gain leveraged exposure to an asset. However, these contracts expire on a specific date, and traders must roll them over to maintain their position. In the early days of crypto, this created persistent issues, including basis and contract expiries that closed positions regardless of the trader's intentions. BitMEX, a derivatives exchange, addressed these problems by introducing perpetual swaps in 2016. These contracts have no expiry date and allow traders to hold positions for any duration. A key mechanism that keeps perps in check is the funding rate, which is exchanged between traders every eight hours. This rate is calculated based on the deviation between the perp price and the spot price, creating a self-correcting equilibrium. Perpetual swaps also offer high leverage, allowing traders to control large positions with minimal 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 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.