Understanding Perpetual Swaps: The Key to Crypto's Hottest Trading Instrument

Perpetual swaps, also known as perpetual futures or 'perps', have emerged as the dominant trading instrument in the crypto market. They allow traders to gain leveraged exposure to the price of bitcoin or other assets without actually owning them. 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 an asset, which would expire on a specific date. However, this created issues in the crypto market, such as basis and contract expiries. BitMEX addressed these problems by introducing perpetual swaps, which have no expiry date and allow traders to hold positions indefinitely. A key mechanism behind perps is the funding rate, which is exchanged between traders every eight hours to maintain price equilibrium. The funding rate is calculated based on the deviation of the perpetual swap price from the spot price. Perps also offer leverage, allowing traders to control larger positions with lower capital. However, this leverage comes with risks, and exchanges use automated liquidation systems to manage these risks. Today, perps are the primary venue for price discovery in crypto, and their structure has proven durable enough to be considered for traditional assets.