Understanding Perpetual Swaps: The Dominant Force in Crypto Trading

Perpetual swaps, or 'perps', are a type of trading instrument that has revolutionized the crypto market. They allow traders to gain leveraged exposure to the price of assets like bitcoin without actually owning them. To comprehend perps, it's essential to understand their origins. In traditional finance, traders typically use futures contracts to gain leveraged exposure to an asset. However, this approach had significant drawbacks in the crypto market, including the persistence of basis and the need for frequent contract rollovers. BitMEX addressed these issues by introducing perpetual swaps, which have no expiry date and allow traders to hold positions indefinitely. The key to perpetual swaps is the funding rate mechanism, which ensures that the contract price remains aligned with the underlying asset's spot price. This mechanism involves the exchange of payments between traders on opposite sides of the market every eight hours, with the rate calculated based on the deviation from the spot price. Perpetual swaps also offer high leverage, allowing traders to control large positions with relatively small amounts of capital. However, this leverage is managed through automated liquidation systems, which close positions before they can incur significant losses. Today, perpetual swaps are the primary venue for price discovery in crypto, with regulators exploring their application to traditional assets. The structure of perpetual swaps has proven durable and has become one of the most traded financial products in the world.