Understanding Perps: The Most Traded Financial Instrument in Crypto

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 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 relied on futures contracts to gain leveraged exposure to assets, which came with an expiry date and required rolling over to maintain positions. However, this approach created persistent problems in the crypto market, including basis and forced position closures. The introduction of perps by BitMEX in 2016 resolved these issues by eliminating the expiry date, allowing traders to hold positions indefinitely. The funding rate mechanism, which involves exchanging payments between traders every eight hours, helps maintain a self-correcting equilibrium and keeps the contract price in line with the spot price. Leverage is another key feature of perps, enabling traders to control large positions with minimal capital. While this creates risks, automated liquidation systems help manage these risks by closing positions before they become negative. Today, perps are the primary venue for price discovery in crypto, with regulators exploring their application to traditional assets. The structure of perps has proven durable, and their impact on the financial world continues to grow.