Understanding Perpetual Swaps: The Dominant Force in Crypto Trading

Perpetual swaps, or 'perps', are a dominant force in the crypto market, processing between $40 trillion to $50 trillion annually. These financial instruments provide traders with leveraged exposure to asset prices without requiring ownership of the underlying asset. 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 leveraged exposure to assets, which would expire on a specific date. However, this approach created issues in the crypto market, such as basis and contract expiries. BitMEX addressed these problems by introducing perpetual swaps, which eliminated the expiry date and enabled traders to hold positions indefinitely. The exchange developed a funding rate mechanism, where traders on opposite sides of the market exchange payments every eight hours, to maintain a self-correcting equilibrium. This mechanism has become the industry standard. Perpetual swaps also offer high leverage, allowing traders to control large positions with minimal capital. However, this comes with significant risk, and exchanges use automated liquidation systems to manage this risk. 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 they have become one of the most traded financial products globally.