First launched in 2016 by BitMEX, the crypto industry has popularised perpetual futures contracts in offshore markets with increasingly strong interest.
Bloomberg reported monthly volumes jumped from $35 billion in January 2018 to $6.4 trillion in May this year, according to CoinDesk Data.
However, this product did not arrive in the US until this summer, when Coinbase filed self-certifications for two perpetual futures contracts in June. And while the Commodity Futures Trading Commission did not object, the oversight agency also has not set any specific guidelines or rules for this novel product.
What are perpetuals?
A perpetual, or perp in industry speak, has no stated expiry date, allowing a party to hold a position until offsetting it to terminate the exposure. They are cash settled trades that provide leveraged exposure to the spot price of an asset, as opposed to providing exposure to a price in the future.
Like traditional futures, perps are margin-based instruments. They allow investors to hold exposure to a notional amount that exceeds the amount of margin they put on deposit.
Perps are traded on an exchange or other organized market with standardized terms and are not typically bilateral contracts entered into over-the-counter with a dealer.
These instruments track the spot price through a so-called funding rate that pays out based on the difference between the contract price and the spot price. This mechanism helps keep the contract trading close to the spot price by incentivizing each party.
If the contract price exceeds the spot price measure, the party trading long must pay the short side of the market. Conversely, if the contract price trades below the spot price, the short side would pay.
Funding payments typically occur on a scheduled basis, such as every eight hours on offshore exchanges or daily on US exchanges. This creates ongoing costs or revenues for traders.
| Key Features | |
|---|---|
| Perpetual Futures | Traditional Futures |
| No expiration date | Expiration date set for daily, monthly or quarterly |
| Price stays relatively aligned with the spot price | No funding rate |
| Leverage often higher than traditional futures, up to 100 times | Leverage typically lower, though varies by exchange |
| Like crypto markets, 24/ access | Like traditional markets, limited to market hours |
Why trade perps?
In addition to no expiry on the position, perps attract retail investors thanks to a few key features.
As opposed to a classic futures contract, perps offer exposure to the spot price without basis risk, although the funding payments can add up over time. Additionally, investors do not have the cost and complications of rolling contracts, since the perp contract remains in perpetuity.
An especially attractive feature for the retail crowd: no physical ownership. Cash settlement removes numerous hurdles to trading.
More broadly, investors use perpetuals for several reasons. Speculators often value the leverage and 24/7 trading hours to take directional positions, hedgers use perps to protect against downside risk while arbitrageurs deploy strategies exploiting gaps between spot, futures, and perp markets, helping to tighten spreads.
Potential problems
Despite the popularity in non-US markets, the CFTC expressed concern around potential manipulation when it requested comment on the trading of perpetuals in May.
How would the funding rate be calculated and would that process offer opportunity for market manipulation? While a relevant question for all cash settled contracts, its relevance increases for perps since it would not impact only one settlement, given the likely daily funding payments of a perp.
The agency also sought comment on the impact perps might have on the liquidity of the broader futures market and this new product’s categorization.
Perhaps Congressional action in Washington, DC will help solve that complexity. However, while the US House or Representatives has passed legislation, the Senate has just begun the process. With any luck, the uncertainty will not run on in perpetuity.
