Unlocking the Mystery of Perps: The Crypto Trading Instrument Taking the World by Storm

Perpetual swaps, commonly referred to as 'perps', have revolutionized the crypto market, facilitating an estimated $40 trillion to $50 trillion in annual trading volume. These instruments have surpassed spot trading in popularity, offering professional traders, hedge funds, and retail speculators a means to gain leveraged exposure to bitcoin and other assets without holding the underlying asset. Despite their widespread adoption, the inner workings of perps remain poorly understood. To grasp the concept of perps, it's essential to examine their predecessors. In traditional finance, futures contracts provide leveraged exposure to assets, with an agreement to buy or sell at a predetermined price on a specific date. Upon expiration, the contract settles, and traders must roll over their positions to maintain exposure. However, this approach created persistent issues in crypto's early days. Futures traded at a premium to the spot price of bitcoin, causing confusion among retail traders seeking straightforward exposure. Moreover, contract expirations resulted in the automatic closure of positions, regardless of the trader's intentions. BitMEX, founded by Arthur Hayes and Ben Delo in 2014, attempted to address these issues by shortening contract durations, but this proved insufficient. The perpetual swap, developed by Delo and launched on BitMEX in 2016, eliminated the expiry date, creating a derivative contract that tracks the asset price indefinitely. This innovation allowed traders to hold positions for extended periods without the need for rolling or settlement. To maintain price equilibrium, a funding rate mechanism was introduced, where traders on opposite sides of the market exchange payments every eight hours. If the perpetual swap price exceeds the spot price, long positions pay short positions, and vice versa. This self-correcting mechanism has become the industry standard. Perpetual swaps also offer leverage, enabling traders to control larger positions with limited capital. To mitigate the associated risks, exchanges employ automated liquidation systems, closing positions before they incur significant losses. The efficiency of these systems has become a key differentiator in the market. Today, perpetual swaps have become the primary venue for price discovery in crypto, with price movements often originating in perp markets before spreading to spot markets. The structure developed by Delo has proven resilient, and regulators are now exploring its application to traditional assets, with the potential for perpetual swaps on equities to be listed on the CME.