Understanding Perpetual Swaps: The Most Traded Financial Instrument in Crypto

Perpetual swaps, also known as 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 the underlying asset. 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 created problems in the crypto market, such as basis and contract expirations. BitMEX, a derivatives exchange, addressed these issues by introducing perpetual swaps in 2016. A perpetual swap is a derivative contract that tracks the price of an asset indefinitely, with no expiry date or settlement. This created a structural challenge, as the contract price could deviate from the spot price. To address this, BitMEX implemented a funding rate mechanism, where traders on opposite sides of the market exchange payments every eight hours. This mechanism has become the industry standard. Perpetual swaps also offer leverage, allowing traders to control large positions with minimal capital. However, this creates risk, which is managed through automated liquidation systems. 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.