Uncovering Perpetual Swaps: The Crypto Market's Most Traded Instrument

Perpetual swaps, also known as perps, have revolutionized the crypto market by providing a unique trading instrument that offers leveraged exposure to asset prices without the need for ownership. With an estimated annual trading volume of $40 trillion to $50 trillion, perps have surpassed spot trading and become the go-to product for professional traders, hedge funds, and retail speculators. Despite their widespread adoption, the inner workings of perps remain poorly understood. To grasp the concept of perps, it's essential to understand the traditional finance context. In the past, leveraged exposure to assets was typically achieved through futures contracts, which had a fixed expiration date. However, this approach created persistent problems in the crypto market, such as basis and contract expirations. The introduction of perps by BitMEX in 2016 addressed these issues by eliminating the expiration date, allowing traders to hold positions indefinitely. The perpetual swap mechanism involves a payment exchange between traders every eight hours, which helps maintain a self-correcting equilibrium. This funding rate mechanism has become the industry standard and is now used by major derivatives exchanges worldwide. Another key feature of perps is leverage, which enables traders to control larger positions with limited capital. To manage the associated risks, exchanges employ automated liquidation systems. Perps have become the primary venue for price discovery in crypto, with bitcoin price movements often originating in perp markets before spreading to spot markets. The concept of perps has proven so durable that regulators are now exploring its application to traditional assets, with the potential listing of perpetual swaps on equities by the CME.