The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these products are ultimately deemed to be swaps rather than futures, a matter that has garnered little attention, CME Group Chairman and CEO Terry Duffy cautioned. In an interview with CoinDesk, Duffy stated, 'There's an ambiguity from a tax perspective for all US participants now.' The comments come as CME continues its legal challenge against the Commodity Futures Trading Commission (CFTC) over the regulator's approval of perpetual futures contracts in the US. A federal court decision is pending, and its outcome could significantly influence the US approach to the rapidly growing field of perpetual futures.
One potential consequence, according to Duffy, is how the Internal Revenue Service (IRS) will ultimately tax these contracts. The dispute centers on whether perpetual futures should be legally treated as futures or swaps. Duffy argued that perpetual contracts, also known as 'perps,' should fall under the legal definition of swaps due to the periodic funding payments exchanged between long and short positions.
Unlike traditional futures, perpetual contracts do not expire; instead, traders periodically exchange funding payments to keep the derivative's price close to that of the underlying asset. Duffy contended that these recurring payment exchanges meet the statutory definition of a swap under US law. 'When two parties exchange payments, that is deemed a swap,' he said, referring to the funding-rate mechanism used by perpetual contracts.
The main issue with this mismatched designation, according to Duffy, is that if perpetual contracts qualify as futures, many institutional traders could receive the blended tax treatment available under Section 1256 of the US tax code. Under this section, gains and losses are generally treated as 60% long-term and 40% short-term capital gains.
However, if these contracts fall under swaps, they will be taxed under 'ordinary' taxation. Given that perpetual futures are newer innovations, the IRS has not issued guidance specifically addressing their tax treatment. If regulators or courts ultimately conclude that perpetual contracts are swaps rather than futures, market participants who have been treating them as futures for tax purposes could face uncertainty about how to report those positions to the IRS.
Legal experts, however, noted that the issue is more complex. 'The challenge is that perpetual futures look like swaps structurally but perform like futures economically,' said Rustin Diehl, a tax attorney and counselor at Allegis Law.
'It's a substance-over-form question, function versus text.' The definition of swaps is extremely broad, leaving considerable room for interpretation regarding its application to new financial products such as perpetual futures. The outcome will depend on how the court interprets it, as the Supreme Court's 2024 Loper Bright decision eliminated the longstanding Chevron doctrine, allowing federal courts to give less deference to agencies' interpretations of ambiguous statutes. This means judges could play a larger role in deciding how existing derivatives laws apply to novel crypto products. The process is likely to be long and drawn out, with potential litigation and tax implications for market participants.