Perpetual Futures for Traditional Assets
It’s refreshing to begin hearing more conversation around the potential for perpetual futures as a primitive in traditional markets.
A lesser known fact is that perps are in fact a cousin of Contract For Differences (CFDs) — cash-settled, synthetic primitives closely tracking the price of an underlying, enabling easy long/short, often (sometimes) with leverage, with no expiry. Yes, there really is a primitive in TradFi that has all these familiar properties, widely traded by tens of millions of retail FX traders globally.
I argue that perps are a fundamentally *better* instrument because of funding rates. This fee type creates a new market structure that makes possible, among other things, non-custodial trading. CFDs, unlike perps, have no natural market mechanism to incentivize balance among long/short. Instead, in broad terms, the platform extends liquidity, takes the other side, and (sometimes) hedges that risk (hedge = “A-Book” model, don’t hedge + bet on trader losses = “B-Book”).
Because there is no clear incentive for traders to go short when others are long (or the inverse) due to the absence of a funding rate, exchanges wind up with unpredictable directional risk they have no natural mechanism to diminish, and wind up manually managing that risk. The exchange itself decides what, and when, and how much, to hedge with a prime broker or another, larger platform — all of which, of course, makes these necessarily custodial platforms.
Introducing a farmable funding rate and other incentives towards Long/Short balance (e.g. open interest imbalance dependent opening fees) enables a gradual shift towards *external arbitrageurs*, rather than the platform itself solely balancing the book. Further, putting the pooled liquidity needed to support trading onchain rather than behind a walled garden managed by the platform and allowing anyone to deposit enables a 100x improvement in transparency vis-a-vis the existing market standard.
This opens up the potential for non-custodial platforms, a radical shift from a broken existing market paradigm where brokers often bet directly on trader losses and internalize that very high margin trade. If, on traditional platforms, trader losses fail to materialize, they often have free license (thanks to loosely defined terms of service) to close trades and even entire accounts that don’t fit the most profitable customer profile with hand-wavey explanations. Not to mention the organizational inefficiency of partially manual monitoring of individual accounts and positions.
I strongly believe the retail FX trading market will be disrupted in the next 5 years and that it will be done by blockchain-based perpetuals. (While confusing, the term “FX platform” is used colloquially to refer to platforms with the above market structure that offer access to hundreds or even thousands of assets beyond currencies, including metals, energy, soft commodities, indices, and in some cases single name equities.)
Just a few of the things we are excited about at Ostium.
Originally published on X. Lightly edited for clarity. July 2024.