Perpetual Futures, Explained

What Are Perpetual Futures?

Much financial innovation serves the real economy. Then we have crypto, which occasionally does intellectually interesting things that don't have a locus in the real economy. Perpetual futures (perps) represent one such innovation - fascinating and worthy of study, yet fundamentally disconnected from productive economic activity.

While stablecoins have recently garnered attention for payment use cases, a plurality of stablecoins actually collateralize perp positions. Of the roughly $300 billion in stablecoins presently outstanding, about a quarter sit on exchanges. The majority of that quarter is collateralizing perp positions.

Perps dominate crypto trading by volume - typically 6-8 times larger than spot trading. This mirrors traditional markets where derivatives are available: derivative volume swamps spot volume. The degree varies by market, Schelling points, and user culture. In India, most retail equity investing occurs through derivatives. In the U.S., most retail equity exposure comes through spot markets (directly holding stocks or indirectly through ETFs/mutual funds), but most stock index trading volume flows through derivatives.

The Core Problem

Large crypto exchanges function primarily as casinos using crypto markets as number sources, similar to traditional casinos using roulette wheels or dice. A casino's function is for patrons to enter with money and, statistically speaking, exit with less. Physical casinos require huge capital investments with large ongoing costs, including returns on speculative capital. If they could choose less capital intensity, they would, but market forces and regulation partially constrain them.

The Trust Requirement

A crypto exchange is also capital intensive, not because websites or APIs took significant investment (relatively low by financial software standards) and not because they have physical plants, but because trust is expensive. Bettors and sophisticated market makers who provide liquidity need to trust the casino will actually pay out winnings. That means exchanges must keep assets (mostly crypto, plus some cash for well-regarded exchanges) on hand exceeding customer account balances.

Those assets sit idle, doing nothing productive. An implicit cost of capital associates with them, whether nominal (borne by gamblers) or material (borne by sophisticated market making firms, exchanges, or exchange-affiliated traders).

Perpetual futures exist to provide the risk gamblers seek while decreasing total capital requirements shared by exchanges and market makers to profitably run the enterprise.

Historical Origins

In commodities futures markets, you can contract to buy or sell standardized valuable things at defined future times. The overwhelming majority of contracts don't result in taking delivery - they're cancelled by offsetting contracts before specified dates.

Given that speculation and hedging are core futures use cases, the financial industry introduced a refinement: cash-settled futures. Instead of physical delivery of pork bellies or oil barrels, reference prices are established (with considerable intellectual effort toward robustness and fairness), and people net short pay people net long on delivery day.

Shiller's Proposal

In the early 1990s, economist Robert Shiller proposed a refinement to cash-settled futures: if you don't actually want pork bellies or oil barrels for consumption in April, and we accept that almost no futures participants actually do, why bother closing contracts in April? Why fragment liquidity between April, May, June contracts? Just keep the market going perpetually.

This achieved first widespread popular use in crypto (Bitmex is generally credited as popularizer). We'll describe the standard crypto implementation, though variations exist.

How Perps Actually Work

Continuous Settlements

Instead of all futures settling on the same day, perps settle multiple times daily for particular markets on particular exchanges. The mechanism: the funding rate. At a high level, winners get paid by losers every few hours (often every 4 hours), then the game continues unless you've been blown out due to overleveraging or other reasons.

Consider a toy example: a retail user buys 0.1 Bitcoin via a perp. The screen price might be $86,000 each, so they pay $8,600 cash. Should the price rise to $90,000 before next settlement, they get approximately $400 winnings credited to their account, and their account continues reflecting exposure to 0.1 Bitcoin units via the perp. They might choose to sell their future at this point (or any other), paying one commission (and spread) to buy, one of each to sell, perhaps leaving the casino with winnings or playing another game.

Where did the money come from? Someone else was symmetrically short Bitcoin exposure via a perp. With important caveats incoming, it's a closed system: since no good or service is produced except speculation, winning money means someone else lost.

Funding Rate Mechanics

One wrinkle: some exchanges cap how much the rate can be for single settlement periods. This resembles traditional markets' circuit breakers in intent: automatically blunting out-of-control feedback loops. It's dissimilar in that it cannot actually break circuits - funding rate changes can delay loss realization but can't prevent them, since they don't prevent symmetrical gain realization.

Perp funding rates also embed interest rate components. This might be quoted as 3 basis points daily, or 1 basis point every eight hours. However, leverage impact means gamblers pay more than expected: at 10X leverage, that's 30 basis points daily. Consumer finance legislation standardizes borrowing costs as APR rather than basis points per day so unscrupulous lenders can't bury 200% APR in fine print.

Price Convergence Mechanisms

Perp prices don't, as a fact of nature, exactly match underlying prices. That's a feature for some users.

The Basis Trade

Generally, when markets are exuberant, perps trade above spot (the underlying market). To close gaps, sophisticated market participants execute the basis trade: make offsetting trades in perps and spot (short the perp, buy spot in equal size). Because funding rates are set against reference prices for underlyings, longs will pay shorts more (as percentages of perp current market prices). For some, that's fine - gambling prices went up, oh well. For others, that's market incentive to close long positions, which involves selling, which decreases price at the margin (toward spot).

Market makers can wait for price convergence; if it happens, they close trades at profit while having been paid to maintain trades. If perps continue trading rich, they just continue getting increased funding cost. To the extent this exceeds their own cost of capital, this can be extremely lucrative.

Flip polarities to understand the other direction.

The basis trade, classically executed, is delta neutral: one isn't exposed to underlying itself. You don't need any belief in Bitcoin's future adoption story, fundamentals, market sentiment, halvings, none of that. You're getting paid to provide the gambling environment, including a critically important feature: perp prices must stay reasonably close to spot prices, close enough to continue attracting gambling participants. You're also renting access to your capital for leverage.

Exchange Risk

You're also underwriting the exchange: if they blow up, your collateral becoming a bankruptcy estate claim is the happy scenario. As one motivating example: Galois Capital, a crypto hedge fund doing basis trades, had roughly 40% of assets on FTX when it went down. They then wound down the fund, selling the bankruptcy claim for 16 cents on the dollar.

Recall that markets can't function without trust systems saying someone is good for it if bettors win. Here, market makers are good for it via collateral kept on exchanges.

Many market makers function across many crypto exchanges. This is one reason they're interested in capital efficiency: fully collateralizing all potential positions they could take across venue universes they trade on would be prohibitively capital intensive, and if they don't pre-deploy capital, they miss profitable trading opportunities.

Leverage and Liquidations

Gamblers like risk - it amplifies the fun. Since one has many casinos to choose from in crypto, ones offering only "regular" Bitcoin exposure (via spot or perps) would offer less-fun products than ones offering leverage. How much leverage? More leverage is always the answer until predictable consequences start happening.

Regulation T Comparison

In standard U.S. brokerage accounts, Regulation T has, for almost 100 years, set maximum leverage limits (by setting margin minimums). These are 2X at position opening time and 4X "maintenance" (before closing positions). Your brokerage would be obligated to forcibly close your position if volatility causes you to exceed those limits.

As simplified example: with $50k cash, you'd be allowed to buy $100k stock. You now have $50k equity and a $50k loan: 2x leverage. Should that stock value decline to about $67k, you still owe the $50k loan, so only have $17k remaining equity. You're now on the precipice of being 4X leveraged, and should expect a margin call very soon, if your broker hasn't "blown you out of the trade" already.

What part is relevant to crypto? For the moment, just focus on that number: 4X.

Extreme Crypto Leverage

Perps are offered at 1X (non-levered exposure). But they're routinely offered at 20X, 50X, and 100X. SBF, during his press tour about being a responsible financial magnate, voluntarily self-limited FTX to 20X.

One reason perps are structurally better for exchanges and market makers is they simplify blowing out leveraged traders. Exact mechanics depend on exchange, amount, etc., but generally you can either force customers to enter closing trades or assign their positions to someone willing to bear risk in return for discounts.

Liquidation Fees

Blowing out losing traders is lucrative for exchanges except when it catastrophically isn't. It's a priced service in many places. The price is quoted as low ("a nominal fee of 0.5%" is one Binance description) but, since it's calculated from amounts at risk, it can be large portions of money lost. If accounts' negative balances are less than liquidation fees, wonderful, thanks for playing and the exchange/"the insurance fund" keeps the rest as a tip.

In cases where amounts accounts are negative by exceed fees, "insurance funds" can choose to pay winners on behalf of liquidated users, at management's discretion. Management usually decides to do this, because casinos with reputations for not paying winners won't long remain casinos.

But tail risk is real. The capital efficiency has a price: there physically doesn't exist enough money in the system to pay all winners given sufficiently dramatic price moves. Forced liquidations happen. Sophisticated participants withdraw liquidity or exchanges become overwhelmed technically/operationally. Forced liquidations eat through diminished/unreplenished book liquidity, and move magnitudes increase.

Then crypto gets reminded about automatic deleveraging (ADL), a perp contract detail few participants understand.

Automatic Deleveraging

Risk in perps must be symmetric: if (accounting for leverage) there are 100,000 Somecoin exposure units long, then there are 100,000 units short. This doesn't imply shorts or longs are sufficiently capitalized to actually pay for all exposure in all instances.

The ADL Mechanism

In cases where management deems paying winners from insurance funds would be too costly and/or impossible, they automatically deleverage some winners. In theory, there's a published process for doing this, because it would cost confidence to ADL non-affiliated accounts but pay out affiliated accounts, one's friends, or particularly important counterparties. In theory.

In theory, one likely ADLs accounts quite levered before ones less levered, and ADLs accounts with high profits before ones with lower profits. In theory.

So perhaps you understood, prior to a 20% move, that you were 4X leveraged. You just earned 80%, right? Except you were only 2X leveraged, so you earned 40%. Why were you retroactively only 2X? That's what automatic deleveraging means. Why couldn't you get the other 40% you feel entitled to? Because the collective group of losers doesn't have enough to pay you your winnings and the insurance fund was insufficient or deemed insufficient by management.

Impact on Sophisticated Traders

ADL is particularly painful for sophisticated market participants doing e.g. basis trades, because they thought they were 100 units short via perps and 100 units long somewhere else via spot. If it turns out they were actually 50 units short via perps, but 100 units long, their net exposure is +50 units, and they've very possibly just gotten absolutely shellacked.

In theory, this can happen to the upside or downside. In practice in crypto, this seems to usually happen after sharp price decreases, not sharp increases. For example, October 2025 saw widespread ADLing as more than $19 billion of liquidations happened across various assets. Alameda's CEO Caroline Ellison testified they lost over $100 million during Terra's stablecoin collapse in 2024, but since FTX's insurance fund was made up, when leveraged traders lost money, their positions were frequently taken up by Alameda. That was quite lucrative much of the time, but catastrophically expensive during e.g. the Terra blowup. Alameda was a good loser and paid the winners, though: with other customers' assets they "borrowed."

Traditional Market Comparison

In traditional markets, if one's brokerage deems one's assets are unlikely to cover margin loans from the brokerage, one's brokerage issues a margin call. Historically that gave relatively short periods (typically a few days) to post additional collateral, either by moving in cash, transferring assets from another brokerage, or experiencing asset value appreciation. Brokerages have options, and sometimes requirements, to manage risk after or during margin calls by forcing trades on behalf of customers to close positions.

Negative Balance Treatment

It sometimes surprises crypto natives that, in cases where one's brokerage account goes negative and all assets are sold with negative remaining balance, traditional markets largely still expect you to pay that balance. This contrasts with crypto, where market expectation for many years was that customers were pseudonymous entities, and dunning them was time-wasting. Crypto exchanges have mostly either stepped up their KYC game or pretended to do so, but market expectation remains that defaulting users will basically never successfully recover.

Loss Allocation

Who bears losses when customers don't, can't, or won't? The waterfall depends on market, product type, and geography, but as a sketch: brokerages bear losses first, out of their own capital. They're generally required to keep reserves for this purpose.

Brokerages, in ordinary business courses, have obligations to other parties that would be endangered if catastrophically mismanaged and could not successfully manage risk during downturns. In this case, most counterparties are partially insulated by structures designed to insure peer groups. These include clearing pools, guaranty funds capitalized by clearinghouse member firms, clearinghouse own capital, and perhaps mutualized insurance pools. That is the rough ordering of the waterfall, varying depending on geography/product/market.

One can imagine true catastrophes burning through each protection layer, and in that case, clearinghouses might be forced to assess members or allocate losses across survivors. That would be a very bad day, but contracts exist to be followed on very bad days.

One commonality with crypto though: this system is also not fully capitalized against all possible events at all times. Unlike crypto, which for contingent reasons pays lip service to being averse to credit even as it embraces leveraged trading, the traditional industry relies extensively on underwriting various participants' risk.

Will Traditional Finance Adopt Perps?

Many crypto advocates believe they have something traditional finance desperately needs. Perps are crypto's most popular and lucrative product, but they probably won't be materially adopted in traditional markets.

Existing derivative products already work reasonably well at solving cost of capital issues. Liquidations are not traditional brokerages' business model. And learning, on a day when markets are 20% down, that you might be hedged or you might be bankrupt, is not a prospect that fills traditional finance professionals with warm fuzzies.

Conclusion

Perpetual futures represent a fascinating financial innovation optimized for one thing: enabling maximum speculation with minimum capital requirements. They solve real problems for crypto exchanges and market makers by reducing capital intensity while maintaining the gambling environment that attracts users.

However, perps create systemic risks that become apparent during extreme market moves. Automatic deleveraging, opaque insurance funds, and extreme leverage create conditions where winning traders may not get fully paid and hedged traders may discover they're catastrophically exposed.

For traditional finance, perps offer lessons but unlikely adoption. The existing derivative ecosystem already addresses capital efficiency needs without introducing the tail risks that make perps problematic for participants seeking actual risk management rather than maximum speculation.

Understanding perps provides insight into crypto market structure and why crypto trading volume looks so different from traditional finance. It's not just that crypto participants are more speculative (though they are) - it's that the infrastructure itself is optimized for speculation rather than productive capital allocation.