The introduction of perpetual futures into regulated markets has sparked intense debate, with critics warning of potential systemic risk due to their association with high-leverage, retail-driven trading. However, this criticism is misguided, as the inherent risk lies not with the perpetual futures contracts themselves, but rather with the design of the trading venue.
The actual risk is determined by factors such as leverage limits, margin rules, index construction, and default handling mechanisms. These elements are not inherent to perpetual futures, which are simply contracts without an expiration date. The real issue is how a venue handles defaults under stress, which can vary significantly even within regulated markets.
Regulatory requirements, such as segregated funds and oversight, are essential to establish a baseline level of security. Nevertheless, the way a venue manages defaults is a separate consideration that can greatly impact the transmission of risk.
The liquidation cascade, often triggered by forced liquidations, can turn a sell-off into a systemic event. This cascade is typically fueled by venue choices, such as a manipulable index and auto-deleveraging mechanisms, rather than the perpetual futures contracts themselves. A more pertinent concern is whether institutions truly want to engage with perpetual futures. A recent JPMorgan note highlighted limited institutional appetite for these contracts, citing their speculative nature and inability to replace regulated futures due to the lack of term structure and basis risk.
However, institutions are not seeking to use perpetual futures as substitutes for dated futures, but rather as a tool to hedge delta exposure, where liquidity is more important than term structure. Many institutions trading options on venues like Bullish use perpetuals to manage their directional exposure to the underlying price, leveraging the deep liquidity these contracts provide.
This liquidity edge is structural, driven by retail demand for perpetual futures, which concentrates liquidity in these instruments. The key to safely utilizing this liquidity is institutional-grade default management, which also helps contain systemic risk. The question should not be whether perpetuals are dangerous, but how a venue handles defaults when the market is under stress.
Regulated clearing has established a standard for managing defaults, which includes absorbing losses through the defaulter's margin and fund contribution, followed by a pre-funded guaranty fund. This approach breaks the chain of risk transmission, preventing a single default from triggering a market-wide cascade. By meeting this standard, perpetual futures can become a valuable infrastructure for institutions, rather than a source of systemic risk.
The design of the trading venue, not the perpetual futures contracts themselves, is the critical factor in determining the level of risk. Chris Tyrer, President of Bullish Exchange, emphasizes that the company has filed with the CFTC to operate as a regulated contract market and clearinghouse, demonstrating its commitment to establishing a secure and reliable trading environment.