Understanding Perpetual Swaps: The Most Traded Crypto Instrument

Perpetual swaps, also known as perpetual futures, have revolutionized the crypto trading landscape. These financial instruments allow traders to gain leveraged exposure to assets like bitcoin without actually owning them. Despite their widespread use, the inner workings of perpetual swaps remain unclear to many. To grasp the concept, it's essential to understand the traditional finance backdrop. Typically, traders use futures contracts to gain leveraged exposure to an asset, which involves agreeing to buy or sell at a set price on a specific date. However, this approach posed persistent problems in the crypto space, particularly with the concept of basis, where futures traded at a premium to the spot price, causing confusion among retail traders. The expiry of contracts also led to unwanted position closures. BitMEX addressed these issues by introducing perpetual swaps in 2016, eliminating the expiry date and creating a derivative contract that tracks the asset price indefinitely. A key mechanism, known as the funding rate, ensures the contract price remains aligned with 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 equilibrium has become an industry standard. Perpetual swaps also offer leverage, allowing traders to control larger positions with deposited capital. However, this leverage is managed through automated liquidation systems to mitigate risk. Today, perpetual swaps are the primary venue for price discovery in crypto, with regulators exploring their application to traditional assets. The structure has proven durable, and its impact on the financial world is undeniable.