Understanding Perpetual Swaps: The Most Traded Financial Instrument in Crypto

Perpetual swaps, also known as perps, are a type of trading instrument that has revolutionized the crypto market. They allow traders to gain leveraged exposure to the price of bitcoin or other assets without actually owning them. Despite their widespread use, the mechanics behind perps are not well understood. To grasp the concept of perps, it's essential to understand the traditional finance context. In the past, traders used futures contracts to gain exposure to an asset, but these contracts had expiration dates, which led to issues such as basis and forced position closures. The introduction of perps by BitMEX in 2016 solved these problems by eliminating expiration dates and creating a self-correcting equilibrium through a funding rate mechanism. This mechanism ensures that the contract price stays close to the spot price of the underlying asset. Perps 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, perps are the primary venue for price discovery in crypto, and their influence is being felt in traditional markets, with regulators exploring their application to equities.