Comment Text:
I appreciate the opportunity to submit comments on the Commission Staff's important Request for Comment regarding “Perpetual” Style Derivatives. Polygon.io is a financial market data provider offering real-time and historical market access across equities, options, forex, indices, cryptocurrencies, and futures. Our engagement with a diverse clientele gives us a unique perspective on the operational, data, and regulatory challenges and opportunities presented by evolving market structures and novel financial products. For this comment, I want to focus exclusively on perpetual derivatives in the cryptocurrency markets. We commend the Commission for initiating this thoughtful inquiry, which represents a crucial step towards establishing a clear regulatory framework for these products. This proactive approach is essential for the U.S. to reassert itself as the financial regulatory leader in this rapidly evolving space. We must move on from the “regulation through enforcement” era into one of clear, comprehensive rulemaking that fosters legitimate innovation while safeguarding market integrity.
The classification of perpetual derivatives under the Commodity Exchange Act (the “Act”) is a critical legal determination. Based on statutory definitions and the Commission’s position in enforcement actions like CFTC v. Eisenberg and BitMEX, derivative contracts referred to as “perpetual contracts” or “perpetual futures” constitute “swaps” under Section 1a(47) of the Act. This classification stems fundamentally from the fact that, at its core, a perpetual derivative is a contract designed to provide continuous exposure to the price of an underlying asset without a fixed expiration date. Whereas traditional futures contracts are defined by a specific maturity date upon which the contract settles and converges to the underlying spot price, perpetuals maintain price alignment through a periodic funding mechanism. This funding rate exchanged between long and short position holders incentivizes the derivative’s price to track the underlying asset or index. Given the Commission’s interpretations of the Act through prior enforcement actions, it appears that the non-expiring nature of perpetuals is the key factor in the Commission’s classification under the existing statutory framework as swaps and, when offered to retail participants on a leveraged basis, as transactions requiring appropriate registration and compliance.
Perpetual derivatives offer compelling advantages compared to other financial instruments available to market participants. The most significant is eliminating rollover costs and complexities associated with managing positions in traditional futures contracts with sequential expiration dates. This provides a seamless tool for maintaining continuous exposure or hedging long-term risk. For markets that trade 24/7, such as cryptocurrencies, perpetuals offer a derivative instrument that matches the continuous nature of the underlying instrument, enabling real-time risk management that is difficult to achieve with products constrained by traditional market hours. This continuous hedging capability represents a risk management feature highly valued by participants in these non-stop markets.
They also contribute to price discovery by providing a continuously traded, leveraged instrument whose price is tightly linked to the underlying asset, reflecting real-time supply and demand dynamics. Use cases include continuous hedging by businesses exposed to commodity price fluctuations, speculative trading based on price movements, and arbitrage strategies exploiting discrepancies between the perpetual price, funding rate, and spot price. These strategies are beneficial to the broader market as they contribute to price alignment, enhance liquidity, and facilitate more efficient price discovery by incentivizing arbitrage activity.
However, these advantages are accompanied by unique risks that demand careful regulatory consideration and robust safeguards. For one, as highlighted in academic studies and observed in market liquidations, the high leverage often available in perpetual markets significantly amplifies potential losses for market participants, particularly retail investors who may not fully appreciate the speed and frequency of liquidations in volatile markets. While key to price alignment, the funding rate mechanism can also be a source of risk and unexpected cost, especially during periods of extreme market sentiment where funding rates can become exceptionally high or low.
Further, these risks are magnified in unregulated or less regulated venues, which currently dominate the perpetual derivatives landscape. The Eisenberg complaint details the alleged manipulation scheme on Mango Markets involving MNGO-USDC Swaps, resulting in the market manipulation and misappropriation of over $100 million. This case is a stark reminder of the vulnerabilities to manipulation, deception, and outright theft on platforms lacking robust market surveillance, clear rules, and accountability. Similarly, the Ooki DAO complaint and the related order highlight how platforms operating outside the regulatory perimeter, explicitly advertising a lack of KYC/AML compliance, facilitated illegal, off-exchange leveraged retail commodity transactions and experienced incidents resulting in the loss of customer funds. These cases are not isolated incidents but exemplify the exact risks that the Act and the Commission’s regulations are designed to prevent and mitigate.
It is important to note that the landscape of perpetual derivatives for cryptocurrencies today is heavily dominated by activity outside the U.S. Perpetual futures on major cryptocurrencies like Bitcoin and Ether are the most actively traded crypto products globally, with daily volumes significantly exceeding those of the underlying spot markets. This activity, representing hundreds of billions of dollars in notional value, occurs predominantly on offshore exchanges. This reality presents a significant challenge for U.S. market participants as they must often access unregulated or less regulated platforms, exposing them to heightened counterparty risk, operational instability, and a lack of robust market integrity safeguards that are standard in U.S. regulated markets.
This is where the Commission’s role becomes critical. Bringing perpetual derivatives into a U.S. regulated framework is not just about capturing market share. It is fundamentally about extending the protections of the Act to market participants trading these products. The Commission’s assertion of jurisdiction over perpetuals as swaps and leveraged retail commodity transactions, demonstrated through enforcement actions like Eisenberg, Ooki, and BitMEX, provides a clear legal basis for this. The experience during the FTX collapse offers a compelling case study as well. LedgerX, a CFTC-regulated derivatives clearing organization and designated contract market, remained solvent and protected customer funds despite the bankruptcy of its parent company, FTX. This was largely a testament to the effectiveness of the CFTC's regulatory oversight, including robust segregation, capital, and risk management requirements. This contrasts with the billions in customer funds misappropriated or lost on unregulated FTX platforms.
Allowing perpetual derivatives to trade on CFTC-regulated exchanges and be cleared by CFTC-regulated DCOs would provide market participants, including retail investors, with access to these products under the protective umbrella of stringent U.S. regulatory standards. This includes mandatory customer fund segregation, rigorous risk management at the clearinghouse level, comprehensive market surveillance, and compliance with KYC/AML requirements. By providing a clear, robust regulatory pathway for perpetuals, the CFTC can facilitate the repatriation of this significant market activity, enhancing U.S. competitiveness and cementing the U.S. position as a global financial hub for responsible innovation in the digital asset space.
The introduction of perpetual derivatives raises several operational and regulatory considerations the Commission must address. Most notably, surveillance in a continuous, 24/7 perpetual market requires real-time capabilities beyond traditional end-of-day processes. Surveillance systems must monitor trading activity, the funding rate mechanism, its potential manipulation, and activity in the underlying spot markets that can influence the perpetual price. This necessitates a sophisticated data infrastructure capable of continuously ingesting, processing, and analyzing high-speed, cross-market data feeds.
Perpetuals also raise unique issues regarding customer default risk and potential FCM/DCO insolvency. Continuous operating hours, high leverage, and rapid price movements mean defaults can occur quickly, potentially increasing risk to other customers if not managed effectively. Robust, real-time risk management systems (dynamic margining, stress testing, liquidation protocols) are essential. Application of insolvency regulations requires careful consideration for orderly transfer/liquidation and customer fund protection, emphasizing continuous, accurate data. Commissioner Johnson’s prior statements on strengthening customer protection and lessons from past insolvencies (e.g., MF Global, Peregrine Financial, and FTX) are highly relevant.
The risk that exists in offering perputals that we have experienced in crypto over the past few years, whether it be platform risk, counterparty risk, or volatility risk, should not be reasons to stand in the doorway or block up the hall. Perpetual style derivatives are a significant market innovation with the potential to offer valuable risk management and price discovery tools, particularly in 24/7 markets like cryptocurrencies. Their unique structure, high leverage, and the current activity concentration on offshore platforms present substantial risks that demand proactive and thoughtful regulatory engagement, which is why it is crucial to bringing these products into the U.S. regulated framework, leveraging the proven effectiveness of CFTC oversight, for the U.S. to lead in this segment of financial markets.
I appreciate the Commission’s willingness to consider public input on this issue.
