Understanding Perpetual Swaps: The Most Traded Financial Product in Crypto

Perpetual swaps, also known as perps, are a type of trading instrument that has revolutionized the crypto market. They allow traders to have leveraged exposure to the price of assets like bitcoin without actually owning them. Despite their popularity, the inner workings of perps are not well understood. To grasp the concept of perps, it's essential to look at their origins. In traditional finance, traders typically use futures contracts to gain leveraged exposure to an asset. However, this approach had significant drawbacks in the crypto space. The introduction of perps by BitMEX in 2016 addressed these issues by eliminating the expiry date, creating a contract that tracks the asset's price indefinitely. This innovation led to the development of a funding rate mechanism, which ensures that the contract price remains aligned with the spot price. The funding rate is calculated every eight hours and involves payments between traders on opposite sides of the market. This mechanism has become the industry standard and is now used by major derivatives exchanges worldwide. Another key feature of perps is leverage, which allows traders to control large positions with relatively small amounts of capital. To manage the risks associated with leverage, exchanges use automated liquidation systems to close positions before they can incur significant losses. Perps 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 also attracted the attention of regulators, who are exploring their potential application to traditional assets.