Understanding Perps: The Most Traded Financial Instrument in Crypto

Perpetual swaps, also known as perps, have revolutionized the crypto market by providing a unique trading instrument that offers leveraged exposure to asset prices without the need for ownership. To comprehend perps, it's essential to understand their origins. In traditional finance, futures contracts are used to gain leveraged exposure to assets, but these contracts come with an expiration date, which can lead to issues such as basis and forced position closures. The crypto market faced similar problems in its early days, with futures trading at a premium to spot prices and contracts expiring, causing positions to close unexpectedly. BitMEX, a derivatives exchange, addressed these issues by introducing perpetual swaps in 2016, which eliminated the expiration date and created a contract that tracks asset prices indefinitely. This innovative solution has become the industry standard, with every major derivatives exchange adopting a similar mechanism. Perpetual swaps work by exchanging payments between traders every eight hours, with the rate of this payment, known as the funding rate, calculated based on the deviation from spot prices. This creates a self-correcting equilibrium, where market makers can profit from the difference between perpetual swap prices and spot prices. Leverage is another key feature of perpetual swaps, allowing traders to control large positions with minimal capital. However, this also increases the risk of significant losses, which is managed through automated liquidation systems. Perpetual swaps have become 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 their impact on the financial world is undeniable, making them one of the most traded financial products globally.