Understanding Perpetual Swaps: The Hottest Crypto Trading Instrument

Perpetual swaps, or 'perps', have revolutionized the crypto market by providing a unique trading instrument that offers leveraged exposure to asset prices without owning the underlying asset. To grasp the concept of perps, it's essential to understand the traditional finance context. Typically, futures contracts are used to gain leveraged exposure to an asset, but these contracts come with an expiration date, after which they settle. However, this created persistent issues in the crypto space, such as basis and forced position closures. BitMEX addressed these problems by introducing perpetual swaps, which eliminate the expiry date, allowing traders to hold positions indefinitely. A key mechanism, known as the funding rate, ensures that the contract price remains aligned with the spot price of the underlying asset. Every eight hours, a payment is exchanged between traders on opposite sides of the market, based on the deviation of the perpetual swap price from the spot price. This self-correcting equilibrium is now widely adopted across major derivatives exchanges. Another defining feature of perpetual swaps is leverage, which enables traders to control large positions with limited capital. To mitigate the associated risks, exchanges employ automated liquidation systems. Perpetual swaps have become the primary venue for price discovery in crypto, with regulators exploring their application to traditional assets. The structure, developed by Ben Delo in 2016, has proven resilient and influential, transforming the financial landscape.