Crypto's New Kingmaker: The Rise of Perpetual Futures - how Trump's victory catapulted crypto derivatives to unprecedented heights

Part Two of a series examining the new landscape of crypto investments, illuminating the meteoric rise of perpetual futures

The crypto market's tectonic plates shifted dramatically in November 2024. The flagship currency Bitcoin surged from $70,000 to $90,000 within two weeks after Trump's electoral triumph.

This rally marked the finest hour for perpetual futures. A $100,000 investment leveraged tenfold could have yielded $350,000 pre-tax in just fourteen days.

Unprecedented flexibility

Not only Bitcoin, but also other cryptocurrencies rose dynamically. As the financial services firm Nansen has published, a trader invested $702,733 in the cryptocurrency Solana and sold it after 7 days in November 2024 for $2,978,298. Another trader bought Ethereum for $948,516 and sold it for $2,211,153 also after 7 days in November 2024.

These exorbitant profits were realized during an extraordinary crypto bull market phase with various financial instruments. Most likely involved: the innovative perpetual futures, also known as perps. “The meteoric rise of perpetual futures or perpetual swaps has eclipsed traditional financial products,” says Patrick Gruhn, CEO and major shareholder of the multilateral trading platform Perpetuals.com, which will offer perpetual futures and tokenized products as well as many traditional financial products when it launches in Q1 2025.

Perps offer unprecedented flexibility. But what exactly are perpetual futures? How did they come to dominate the crypto derivatives scene? And why should savvy investors pay attention to this innovative financial tool?

The Genesis of Perpetual Futures

To understand the allure of perpetual futures, one must delve into their origins. The concept is often attributed to economist and Nobel Prize winner Robert Shiller who proposed perpetual futures in 1992, but the origins go back to the 1980s. However, it wasn't until 2016 that this idea was brought to life in the digital asset space.

Traditional futures contracts have expiration dates, forcing traders to regularly "roll over" their positions. This process can be cumbersome and costly. Perpetual futures, in contrast, have no expiration date. They allow traders to hold positions indefinitely, offering unprecedented flexibility.

The first perpetual futures contract, the "Perpetual XBTUSD Leveraged Swap", was launched on May 13, 2016. This innovative product quickly gained traction, sparking a revolution in crypto trading.

The Mechanics of Perpetual Futures

At their core, perpetual futures are derivative contracts that track the price of an underlying asset, typically a cryptocurrency like Bitcoin. Unlike traditional futures, they don't have a set expiration date. Instead, they use a unique mechanism called the "funding rate" to keep the contract price aligned with the spot price.

The funding rate is a periodic payment between long and short position holders. If the perpetual future price is higher than the spot price, longs pay shorts. If it's lower, shorts pay longs. This ingenious system ensures the futures price remains tethered to the spot price, preventing significant divergence.

The Advantages of Perpetual Futures

Perpetual futures offer several compelling advantages that have fueled their rapid adoption:

1. Flexibility: Traders can hold positions indefinitely without worrying about expiration dates or rollover costs.

2. Capital Efficiency: High leverage allows traders to control large positions with relatively small capital outlays.

3. 24/7 Trading: Unlike traditional markets, crypto never sleeps. Perpetual futures allow traders to capitalise on opportunities around the clock.

4. Lower Fees: Many platforms offer lower transaction fees for perpetual futures compared to spot trading or traditional futures.

5. Hedging Opportunities: Perpetual futures provide an excellent tool for portfolio hedging, allowing traders to protect against adverse price movements.

The Explosive Growth of Perpetual Futures

The rise of perpetual futures in the crypto space has been nothing short of phenomenal. According to a study by He, Songrun et al., the trading volume of perpetual futures rose from $8.551 billion (2020) to 39.306 billion (2022). On 13 November 2024, EDX Markets reported a record volume of $685 million in a 24-hour period.

The data shows that trading volume has increased sharply since 2020 and stabilised at a high level, with perpetual futures volume significantly exceeding spot trading volume. Several factors have contributed to this growth:

1. Accessibility: Many crypto exchanges have made it easy for traders to access perpetual futures markets.

2. Liquidity: The perpetual nature of these contracts concentrates liquidity in a single instrument, rather than spreading it across multiple expiry dates.

3. Leverage: The ability to trade with high leverage appeals to risk-tolerant traders seeking amplified returns.

4. Market Conditions: The volatile nature of cryptocurrencies makes perpetual futures an attractive tool for both speculation and hedging.

Practical Applications of Perpetual Futures

To illustrate the versatility of perpetual futures, consider these concrete trading strategies:

1. Long-term Positioning: A trader convinced of a long-term rise in Bitcoin's price could open a long position in BTC/USD Perpetual Futures. Unlike traditional futures, there's no need to worry about rolling over the position.

2. Short-term Momentum Trading: During sudden market movements, traders can react swiftly. For instance, upon positive news, a trader might open a long position to profit from the short-term upward movement.

3. Arbitrage: Experienced traders exploit price differences between perpetual futures and the spot market. If the perpetual future trades above the spot price, they might short the future while simultaneously buying Bitcoin in the spot market.

4. Hedging: A Bitcoin miner could use perpetual futures to hedge against price fluctuations. By entering a short position in BTC/USD perpetuals, they can protect a portion of their future production against price declines.

Perpetual Futures vs. Traditional Financial Instruments

Compared to traditional financial instruments, perpetual futures offer unique advantages. Unlike Contracts for Difference (CFDs), perpetual futures are typically traded on specialized cryptocurrency exchanges where price discovery is a function of pure supply and demand. This transparency engenders trust, allowing investors to witness market dynamics in real-time.

Moreover, the funding rate mechanism of perpetual futures creates a self- correcting system that thwarts manipulation attempts and fosters market efficiency. This is a significant improvement over traditional derivatives, which can sometimes suffer from opaque pricing mechanisms.

The Regulatory Landscape

As perpetual futures have gained prominence, regulators have taken notice.

In Europe, these instruments are classified under MiFID II, typically falling under Annex I, Section C(10) as "other derivative financial instruments" when traded on multilateral trading facilities or regulated exchanges.

However, when traded on platforms with market makers or single principals, they may be classified as CFDs under the principle of "substance over form". This nuanced classification reflects the complexity of modern financial instruments and the regulatory framework's attempt to adapt to evolving market structures.

The regulatory landscape for perpetual futures is complex and varies significantly between jurisdictions:

In the European Union, perpetual futures are regulated under MiFID II. Depending on the trading platform, they can be classified as “other derivative financial instruments” or as CFDs. This distinction has a significant impact on the applicable regulations and investor protection. With Perpetuals.com, which has the focus on perpetual futures in its name, investors can be very confident that they will enjoy security and transparency under the highest applicable European regulatory standards - MiFiD II and MiCA. In the United States, the Commodity Futures Trading Commission (CFTC) has classified cryptocurrencies as commodities, bringing perpetual futures under its purview.

These different approaches pose a challenge for global traders, who need to be acutely aware of and comply with the specific rules in each jurisdiction in which they operate. Perpetuals.com, which will launch as a trading platform in Q1 2025, has solved these challenges in terms of transparency and regulated security for the investor.

The Future of Perpetual Futures

As the crypto market continues to mature, perpetual futures are likely to play an increasingly important role. Their flexibility, efficiency, and transparency make them an attractive option for both institutional and retail investors.

However, it's crucial to note that trading perpetual futures, like all crypto investments, carry risks. The high leverage available can amplify losses as well as gains. Traders should approach these instruments with a thorough understanding of their mechanics because perpetual futures can introduce new complexities.

Patrick Gruhn, CEO of Perpetuals.com, offers a clear perspective: "Perpetual futures represent the pinnacle of cryptocurrency trading innovation. Their transparency, efficiency, and alignment with market dynamics make them the superior choice for serious digital asset traders."

Embracing the Perpetual Future

For savvy investors looking to navigate the crypto markets, understanding perpetual futures is no longer optional – it's essential. These innovative instruments offer unparalleled flexibility, efficiency, and opportunities for both speculation and hedging.

As you consider incorporating perpetual futures into your trading strategy, remember:

1. Education is key. Thoroughly understand the mechanics of perpetual futures before trading.

2. Start small. Begin with modest positions to familiarize yourself with the market dynamics.

3. Manage risk carefully. Use stop-loss orders and avoid over-leveraging your positions.

4. Stay informed. Keep abreast of market trends and regulatory developments in this rapidly evolving space.

5. Choose your platform wisely. Opt for reputable exchanges with robust security measures and transparent operations.

In conclusion, perpetual futures represent a significant leap forward in the evolution of crypto trading. As these instruments continue to reshape the landscape of digital asset markets, they offer exciting possibilities for those willing to embrace the future of finance.

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