Yet, despite all that adoration, few in the world of traditional finance have ever heard of the instruments. Even fewer appreciate that they could transform how interest-rate, FX, and funding markets operate if they’re ever fully legalized.
So before armies of bank analysts and McKinsey consultants churn out 50-page “special reports” on perps to prove they were ahead of the curve all along, here’s what you need to know to get ahead of the curve.
Let’s begin with what perpetual futures are.
In their purest form, ‘perps’ are derivative instruments that, unlike classic futures, do not have an expiration or settlement date. Instead, they provide continuous exposure to the underlying asset without ever requiring periodic rollovers. This is achieved by stripping out the funding cost from the asset being traded. The result is an instrument that emulates the spot price almost perfectly.
Yet, despite their huge popularity with crypto exchanges and DeFi systems, their unregulated status means they bear all the risks associated with having to operate with legal uncertainty. Here they share much in common with the regulatory journey that stablecoins have been on.
Traditional finance was slow to grasp the implications of stablecoins being fully integrated into the official system. Few recognized how profoundly these instruments would alter interest-rate markets and yield curves (perhaps clinging to the hope they never be approved). Others overlooked the possibility that the U.S. Treasury — drawn by their fiscal utility — might one day not just embrace them enthusiastically but them front and center of policy.
Today, markets appear similarly blind to how the regulatory sands are shifting on perp adoption, or the benefits they could provide to Treasuries if fully adopted.
But the regulatory landscape really is shifting.
In the U.S., the CFTC recently solicited public comment on perpetual contracts and is now seeing exchanges self-certify BTC/ETH perpetual futures — suggesting perps could be brought onshore under CFTC jurisdiction.
In Europe, ESMA’s guidelines are currently being clarifyied to determine when crypto assets and derivatives fall under MiFID II regimes, and under what conditions regulated perpetuals (or derivatives of crypto) could be permitted to operate.
Hong Kong, meanwhile, is shifting from a prohibition regime toward a tiered opening where derivatives won’t be broadly allowed for retail in the near term, but regulated derivative access could be enabled for qualified, institutional, or professional players under new guardrails.
At Token 2049 in Singapore this week (one of the world’s largest crypto fairs) participants were confidently predicting perpetual futures could become fully legal in the U.S. within 12 months.
Despite the evolving regulatory mindset, “serious” financial media outlets are yet to pick up on their potential.
A quick check for “perpetual futures” in Politico’s archive, for example, draws zero results.
So why does any of this matter?
Here’s where things get interesting. For the most part, the transformative potential of perps lies not in their ability to synthesize spot markets, but rather, in opening the door to an active and transparent market in intraday funding. Specifically, they empower price discovery at the shortest end of the dollar (and other currencies) funding market.
Many would think that in the age of instant settlements and real-time gross payments there’s a market for such funding already. But weirdly enough there isn’t.
Bank’s intraday imbalances are currently handled in opaque ways, most often via the provision of intraday credit (usually on a collateralized basis) from central banks. The cost of this liquidity is determined at the policy level. As a rule, markets are not privy to how much intraday credit is being tapped at any given time, or what banks, if any, are stepping in to cover other banks’ shortfalls or at what price. For now, this works to the advantage of institutions like JPMorgan, which dominate the market for balancing such flows.
When we first spotlighted that perpetual futures could bring transparency and efficiency to the market, few — especially within the interest-rate-trading community — understood the rationale or even the need for such an evolution. Even central bankers pleaded ignorance.
Today, however, the idea that the system may require new and more responsive tools to manage daily liquidity imbalances isn’t as far-fetched as it used to be.
Last week, Dallas Fed President Lorie Logan, espoused the need to modernize the Fed’s FOMC operating target rate to ensure it better reflects the industry’s embrace of secured financing. While she stopped short of calling for an explicit intraday mechanism, she did advocate for the Fed to seek more effective ways to enforce its policy corridor, which currently is far too dependent on Fed funds (an unsecured rate). One idea she pitched was to focus more explicitly on enforcing its corridor by using interest on reserves to set a hard floor, and the rate charged on the Fed’s Standing Repo Facility (SRF) and the Foreign and International Monetary Authorities (FIMA) repo facility to set a ceiling on secured rates.
Yet, with stablecoins — the ultimate form of short-term secured financing — fast becoming the ultimate source of short term liquidity and repo financing, it’s worth considering how that Fed set-up might adapt over time.
Key to this is the fact that stablecoins are already the main mechanism by which many different decentralized funding pools in the crypto world fund eachother in real-time intraday.
Crypto traders will tell you: you can’t go far in “defi” systems without bumping into a perpetual future trying to pool, price, or distribute stablecoin liquidity further throughout the system.
In that sense, perpetual futures are to stablecoins what repo rates are to money market funds.
Over at Token 2049, a growing array of voices were beginning to understand this relationship.
Charles Cascarilla, CEO and co-founder of Paxos, the stablecoin infrastructure provider, argued stablecoins could soon democratize the true risk-free rate so that everyone, not just banks, can take advantage of it. He explained they were a way of “taking (interest rate) profits that are sitting somewhere else, giving that to the end user, and creating a user experience that your customers are going to like, and that will drive adoption.”
This is evidenced by the fact that Paxos is currently competing with another crypto firm, Agora, for the opportunity to issue and manage HyperLiquid’s foray into stablecoin self-issuance.
What is Hyperliquid? It is a major decentralized crypto derivatives exchange, specializing in perpetual futures trading, which emerged in the aftermath of the collapse of FTX. It, like most exchanges, depends on third-party stablecoins such as Tether to provide traders with the means of banking profits or shorting cryptos with perps. As noted already, perps synthesize the spot rate of any given crypto by stripping out the cost of money from the underlying derivative. They do this most notably by providing an active and variable intraday market in the cost of funding such instruments.
In the case of Hyperliquid, it now believes it is big enough to launch its own stablecoin for customers to use, rather than depend on third-party ones like Tether. A key advantage of doing so is that this will allow Hyperliquid to benefit from the interest proceeds generated by the underlying assets backing the stablecoin, and distribute them back to its own community.
This contrasts with Tether — also born out of traders’ need to park value in an instrument that synthesized the dollar on its sister exchange, Bitfinex — which famously issues its synthetic dollar to users at a zero interest rate. This allows Tether to pocket the interest derived from the underlying assets for itself.
But the days of running such a shameless opportunistic model may be coming to an end. Market players are wising up to the arbitrage, and competitors are coming in to eat Tether’s lunch.
As part of the competition to win Hyperliquid’s stablecoin business, for example, Paxos is competing over what share of interest derived from the underlying assets it should retain and what it should pass back to the Hyperliquid community.
Whoever wins the business, the rate will obviously fluctuate with the risk-free rate of USTs, all the more so if the stablecoin is backed by extremely short-dated bills.
As a result, the funding rates being used to support Hyperliquid’s perpetual futures will be far more indicative of real-time dollar funding fundamentals than those indicated by the Tether stablecoin. They could even become an important mechanism for luring funding out of highly speculative crypto markets (which then become a de facto system-wide funding shock absorber) into dollar markets proper.
This, in turn, should open the door to an actively traded intraday funding market, as derived from the real-time cost of short-term government borrowing, which banks would feel compelled to compete with or lose business (and funding) to crypto stablecoins.
A metabolic financial system
This will make the market behave much more like power or natural gas markets. Both are known for their intraday volatility and sensitivity to daily disruptions on the back of having to balance at zero at all times.
And while the central bank will be able to intervene when conditions are particularly stressed or volatile (like a baseload provider in electricity markets) it will no longer have to do so at the expense or risk of having to maintain huge sums of QE-generated excess reserves on its own balance sheet for extended periods of time.
Thanks to stablecoins, those assets and risks can now be redistributed more widely across private sector balance sheets. Like taking a single deposit of fat in a living organism, and distributing it across many different areas of the body.
But also, since the cost of carrying that fat (aka excess liquidity) will now be priced by a competitive market mechanism and at real time, the net outcome may well be that the overall amount of fat the system has to bear is greatly reduced. In that case the result will be a metabolic regulation of the system.
By the same measure, if and when stablecoin fat depots become too expensive to maintain on private balance sheets because deflationary forces are leading to zero or negative yielding government debt, access to “safe fully collateralized liquidity” can be charged accordingly and responsively.
For those stablecoins whose clients would rather take credit risk than pay a fee (aka take a punt that unfunded dilution and credit allocation will turn negative returns into positive returns), they could apply for banking licenses instead.
