How a Chance Encounter on a Hong Kong Hike Revolutionized Crypto Trading

In 2015, a hike in Hong Kong's countryside sparked an idea that would go on to transform the world of crypto trading. Ben Delo, co-founder of BitMEX, was discussing the challenges of creating a futures contract that met the needs of his customers with his friend Bavik, a derivatives trader. The problem they faced was that existing futures contracts were not working as intended, with customers complaining about positions closing without warning. Delo's question, 'What if a future never expired?' led to a pivotal moment in the development of the perpetual swap, a financial product that would eventually become a cornerstone of the crypto derivatives market. The concept of a perpetual swap, also known as a perp, was born out of this conversation. It was a simple yet ingenious idea - a futures contract with no expiry date, anchored to the spot price through a daily funding rate. Longs would pay shorts, or vice versa, depending on whether the swap was trading above or below spot. The funding rate was designed to be a balancing mechanism, ensuring that the contract price remained aligned with the actual price of the underlying asset. The launch of the perpetual swap in May 2016 marked a significant turning point for BitMEX, which had been struggling to find its footing in the competitive world of crypto trading. The exchange had initially focused on serving institutional hedgers, but it was the retail traders who ultimately drove the demand for the perpetual swap. These traders were looking for a product that would allow them to speculate on the price of bitcoin with high leverage, and the perpetual swap fit the bill perfectly. The success of the perpetual swap was not without its challenges, however. As the price of bitcoin began to rise in 2016 and 2017, the funding mechanism came under strain. The contract price started to drift away from the spot price, causing concerns about the stability of the market. Delo and his team had to dynamically adjust the funding rate to keep the contract price aligned with the spot price. The solution they came up with was elegant and effective. Instead of relying on external lending markets to determine the funding rate, they began to measure the gap between the swap price and the spot price over an eight-hour window. This gap was treated as an implied basis, and the annualized rate was back-calculated from it. The new funding rate mechanism was a game-changer for the perpetual swap. It allowed market makers to anticipate and respond to changes in the market, creating a dynamic equilibrium that kept the contract price aligned with the spot price. Today, the perpetual swap is one of the most widely used financial products in the crypto derivatives market. Its impact has been felt far beyond the world of crypto, with traditional finance regulators taking notice of its potential. The CFTC is reportedly making room for perpetual swaps under its framework, and there is speculation that the CME could eventually list them on equities. For Delo, the success of the perpetual swap is a testament to the power of innovation and the importance of listening to customers. It is a reminder that even the most complex financial products can be simplified and made accessible to a wider audience, and that the next big thing in finance is often just a conversation away.