Critics say perps are all froth. The numbers suggest otherwise
Terry Duffy is a worried man. At least, his recent statements on perpetual futures would suggest as much.
The chief of derivatives exchange giant CME is worried that the expiry-less instruments pose a systemic risk to the financial system, describing their high leverage as a “disaster waiting to happen” at an industry conference last June.
But he’s also worried that the runaway growth of the upstart product, which retail investors use to bet on the price of cryptocurrencies and other assets, may take a chunk out of the business model of incumbent exchanges like his own. So much so, that CME launched a lawsuit in June against the Commodity Futures Trading Commission, challenging the regulator’s decision to approve bitcoin perpetuals offered by prediction markets provider Kalshi.
Meanwhile, Duffy is keen to undermine the institutional case for perps, saying in CME’s July earnings call that the company has “not heard demand from our customers for these products”, dismissing them as a “speculation market”.
If you look at the bare facts, he may have a point.
A rough and ready way to measure the amount of speculation in a market is to compare daily trading activity and levels of open interest. Open interest is the number of contracts outstanding at any one time. Low open interest relative to trading volumes would indicate a market dominated by short-term, speculative activity or meaningless churn; the kind of fickle, flighty traders who generate one-way flows.
Kalshi’s bitcoin perpetual recorded daily volumes of $427 million on August 25. Open interest stood at a measly $9.4 million – a hallmark of exactly the kind of speculative-heavy market that Duffy described. Markets with too much of this activity can turn on a dime (or bitcoin), hurting investors when liquidity vanishes and bid/offer spreads balloon.
So, what should a healthy, liquid futures market look like?
CME’s E-mini S&P 500 futures are one of the most traded equity index contracts, boasting high levels of institutional activity. On August 24, daily trading volumes were 1,091,578 contracts versus open interest of 2,042,853 contracts.
In rates, CME’s three-month SOFR futures are another useful yardstick for a thriving futures market. On August 24, daily trading volumes were 2,844,679 contracts, with open interest at 13,060,705 contracts.
In both these markets, open interest dwarfs daily trading volumes.
Perps don’t just reference crypto assets, though. A growing part of perpetual volumes is on traditional underlyings: crude oil, precious metals, equities, foreign exchange. Offshore exchange Hyperliquid reported average daily volumes of nearly $4 billion in these so-called TradFi perps in August.
The levels of open interest in these instruments might pique the interest of Terry Duffy et al. Hyperliquid’s perpetual contract tracking the S&P 500 registered daily volumes of $242.65 million on August 23. Open interest was at $453.23 million.
The relative size of these two figures is more akin to popular CME futures than Kalshi’s bitcoin perps.
There is a caveat in any comparison between CME and perpetual futures venues, as CME cites the number of contracts while Kalshi and Hyperliquid report in dollars. In crude terms, though, open interest greater than daily volumes is a sign of a market with ‘sticky’ trading, or longer-term commitments from parties.
These longer-term traders are often hedgers: pension funds who hedge trillions of dollars of liabilities using interest rate derivatives, or corporates laying off foreign exchange exposures. Institutions such as these are the lifeblood of traditional derivatives exchanges like CME, Ice and Eurex.
Hedging is good for exchanges. It’s regular and reliable. It doesn’t take flight at the first sign of trouble. It’s not one-sided.
Speculators, by contrast, are only here for a good time, not for a long time.
Alongside hedgers and speculators, another key constituent of derivatives exchanges is liquidity providers. These firms quote bid/offer prices, providing a service to the exchange by lubricating markets. In return, exchanges typically incentivise market-makers by offering generous rebate schemes or bonus payments.
A healthy market needs all three types of participants to thrive. Think of it like the NPK mix for agriculture. Fertilisers contain a blend of nitrogen, phosphorous and potassium, each performing a specific function for plants: leaf growth, root development and disease prevention. The balance of the three is crucial: too much of one and not enough of another, and you risk killing the plant.
Similarly, exchanges can wither and die if the balance of participants is not right. Nasdaq launched its London-based interest rate derivatives exchange, NLX, in 2013, tempting market-makers and prop traders with fee waivers and rebates. But a lack of sticky trading caused open interest to fade and the exchange closed in 2017.
Likewise, Eurex has adjusted the incentive scheme for its short-term interest rates futures products, in a bid to counter criticism that liquidity on the exchange is fragile and activity is dominated by low-risk, high-churn trades.
As Hyperliquid and Kalshi try and build an institutional client base and a sustainable ecosystem to grab market share from the large exchanges, the likes of Eurex and CME will be tracking their progress closely with the fate of NLX in the back of their minds.
Editing by Helen Bartholomew
