Streetwise Professor

Perpetual futures are all the rage these days. Few things in the futures space have attracted as much attention as “perps,” in particular in the aftermath of a surge in crude oil perpetual futures trading on Hyperliquid over the weekend when the US and Israel unleashed their bombing campaign against Iran–a time when the major exchanges were closed. Below is a policy piece I prepared for ICE that examines the economics of perps. The basic conclusion: they are suitable primarily for a retail trading niche which represents a small fraction of incumbent exchanges’ business.

The Economics of Perpetual Commodity Futures

Introduction

Perpetual futures (“perpetuals” or “perps”) were developed initially to solve specific security problems in trading cryptocurrency (“crypto”). From their birthplace in the crypto markets, perpetual futures have moved into the trading of virtually every major asset class, including inter alia equities, equity indices, and currencies. And now they are making inroads into commodities like oil and corn. The Iran War triggered broader awareness of this latter trend: the volume of a crude oil perpetual futures contract traded on Hyperliquid soared to $1.7 billion with the onset of the war.[1]

This, in turn, has sparked considerable debate over how perpetual futures will affect the traditional conventional commodity futures markets, including ICE and the CME. Herein I present an economic analysis of perpetual futures. [2] The primary conclusions are:

• Due to their design, perpetual futures are ill-suited for market participants who account for a preponderant share of trading on incumbent exchanges. These are large commercial and financial entities who use traditional futures contracts to transfer risk. Crucially, the spot price mimicking structure of perpetual futures does not align with the risks that commercial hedgers manage.
• Instead, perpetual futures are tailored to small “retail” traders. As a result, perpetual futures are likely to be a niche product that is attractive to this clientele.
• The competitive impact of perpetual futures on commodity derivatives markets will depend on whether these contracts attract retail volume from incumbent exchanges, or instead disproportionately attract traders who would not trade on these exchanges.

Commodity Perpetual Futures

Perpetual futures emerged in the cryptocurrency market to solve a particular problem: recurrent thefts of cryptocurrency held by exchanges trading actual crypto (“spot exchanges”).[3] Introduced by BitMEX in 2013, perpetual futures avoided the security issues that had plagued spot exchanges because they were cash-settled instruments that did not allow, require, or countenance the delivery of crypto assets, or the custody thereof.

Incumbent crypto exchanges traded crypto assets on a spot basis, in much the same way that the NYSE or Nasdaq trade equities on a spot basis. Perpetual futures were designed to mimic spot trading but to avoid the security issues just described. Specifically, with perpetual futures, on a periodic basis throughout the day a perpetual futures exchange determines a price from an “oracle” that takes the prices from spot exchanges. The perpetual futures exchange then compares the price of its perpetual contract (for Bitcoin, say) to the price derived from the oracle. If the prevailing price on the exchange’s perpetual diverges from the oracle price (a measure of the spot price of the instrument), the exchange determines a “funding rate.” If the perpetual price is above the oracle price, the contract long pays the funding rate, and the short receives a funding rate payment.

This is intended to, and has the effect of, causing the perpetual price to track the spot price prevailing on spot exchanges. A perpetual price above the spot price incentivizes sale of the perpetual to capture the funding payment, thereby driving the price: conversely, a perpetual price below the spot price incentivizes a purchase of the perpetual, again to capture the funding payment, thereby driving up the price. These sales and purchases tend to drive the perpetual price towards the spot price, thereby causing the perpetual price to track spot prices closely. In this way, a perpetual futures trader can obtain exposure to the underlying spot price as could be obtained directly on a spot exchange, but without the security risks posed by trading on a spot exchange.

Market participants soon realized that perpetual futures offered other advantages.

First, unlike conventional futures contracts, perpetual futures have no fixed expiration date. Thus, whereas trading traditional futures requires those who wish to hold a position over a contract expiration date must “roll” these positions on or before the expiration date, this is unnecessary for a perpetual future. For example, with conventional futures, a long must sell the expiring contract and buy a later-expiring contract to maintain a long position, whereas a trader long the perpetual need not do anything. This economizes on transactions costs. 

Second, like futures but unlike spot transactions, perpetual futures incorporate leverage. For example, perpetual exchanges offer 10x, 20x, and sometimes as much as 50x leverage.

Third, like conventional futures, perpetual futures are easier to short than actual cryptocurrencies.

Fourth, perpetual futures offer 24×7 trading. In contrast, at present, conventional exchanges trade for less than 24 hours a day, and on weekdays.

As a result of these various features, perpetual futures have come to dominate crypto trading. A recent JP Morgan study estimates that perpetuals account for 90 percent of crypto derivatives trading (with conventional futures traded on exchanges like the CME representing the rest), and that perpetual futures volumes exceed spot exchange volumes.

Perpetual futures differ from conventional futures in other ways. Unlike conventional futures traded on ICE or CME, many perpetual futures are not centrally cleared.

Moreover, and relatedly, perpetual futures often have an “auto-liquidation” feature. As an example, on Hyperliquid, as on a traditional cleared market, the exchange sets an initial margin level and a maintenance margin level: these levels effectively determine leverage, with lower margins being associated with higher leverage. If the market moves against a trader and the loss drives the trader’s account equity below the maintenance margin level, Hyperliquid reduces or closes the position by engaging submitting an offsetting market order into the exchange limit order book, for example, selling when a long’s account equity is insufficient.[4] If the trader’s equity falls below two-thirds of the maintenance margin level, the position is transferred to a “Liquidation Vault,” which essentially internalizes the offsetting transaction.[5] In extreme circumstances, when the market liquidation fails and the Liquidation Vault cannot safely absorb the position loss, the exchange may trigger “Auto-Deleveraging,” whereby profitable positions on the opposite side of the market can have their positions reduced. This is effectively a “tear up” procedure.

Auto-liquidation mitigates credit risk in leveraged instruments, but can have destabilizing effects. For example, a large price increase likely results in large auto-liquidations of short positions, which tends to cause prices to increase further. In the case of perpetual futures, the price change will manifest itself primarily in the form of an increased spread between the perpetual price and the spot price it is intended to track, leading to large funding payments that require access to funding liquidity. Liquidity strains can exacerbate this mechanism.[6]

Commodity Perpetual Futures

Although perpetual futures developed in crypto markets to address crypto-specific problems, their market success has spurred the extension of the concept to a wide variety of other underlying instruments, most notably commodities such as crude oil. With respect to commodities specifically, perpetual futures differ in salient dimensions from crypto perpetual futures and even perpetual futures on other non-crypto-underlyings, such as equity indices.

There is one overriding reason for this difference: there are no transparent and liquid spot markets as there are for cryptocurrencies and many other financial assets. Thus, it is impossible to create commodity perpetual futures that track (as a result of funding payments) a spot commodity price, because for all practical purposes such a thing does not exist.

Instead, existing commodity perpetual futures are designed to track the prices of liquid futures contracts, such as CME NYMEX WTI Crude Oil Futures and ICE Brent Crude Oil Futures. With that difference, commodity perpetual futures operate similarly to the crypto perpetuals described above.

Specifically, a perpetual futures exchange obtains the price of the futures it is tracking from an oracle, and sets funding payments based on the difference between the perpetual futures price and the oracle price. For example, on 3 August 2026, Hyperliquid receives the price of September 2026 WTI Crude Oil Futures on an hourly basis from its oracle.[7]  As described above, it determines a funding payment based on the difference between the WTI perpetual futures price at that time and the Crude Oil Futures price determined from the oracle. Further, as already described, funding payments incentivize market participants to make transactions that tend to diminish the difference between the perpetual futures price and the price of the underlying futures contract.

As a result of this mechanism, the perpetual futures price tracks a futures price. But what futures price? The underlying futures contracts expire, meaning that the perpetual futures exchange must periodically shift the identity of the underlying futures contract whose price the perpetual future tracks.

There are many ways to do this. One way would be to shift at the end of trading of a particular futures contract, which would be 2:30 p.m. Eastern Time on the last trading day of an expiring contract, at which time the tracking would shift from the just-expired contract to the now front-month contract.

Due to the nature of commodity forward curves, where prices of adjacent futures contracts can differ substantially (a subject I return to below), such a mechanism would lead to abrupt changes in the perpetual futures price. Exchanges have therefore adopted other mechanisms that result in a smoother transition.

Hyperliquid, for example, has a five-day roll period running from the fifth to the tenth business day of the last month of trading of a contract.[8] On the fifth day, the reference price equals the price of the next expiring (front month) contract. On the fourth day, the reference price equals .8 times the front month price and .2 times the second month price. On each successive day, the weight on the front month contract falls by 20 percent, and the weight on the second month contract rises by that amount. This continues until on the tenth business day of the month, at which time the reference price equals 100 percent of the second month contract price. This mechanism effectively smooths out the effect of differences between front month and second-month underlying prices on the price of the perpetual.

The Economic Function of Commodity Futures

Futures markets serve two primary purposes: risk transfer and price discovery. Risk transfer relates to hedging: those who wish to reduce their exposure to the price of a particular commodity can take an offsetting exposure through the futures market, thereby transferring their risk either to a hedger with a mirror image risk exposure, or to a speculator who is willing to take on the risk in the expectation of earning a profit. Price discovery is a valuable byproduct of futures trading undertaken for hedging or speculative purposes. Those with private information (about fundamentals, for instance) trade on that information, for instance buying when their information suggests that the current price is too low. These privately informed trades tend to move prices in the direction of the private information that motivates them, thereby causing prices to reflect this information. The aggregation of private information in futures prices through this mechanism is valuable, because more informative prices guide better resource allocation decisions.

Different types of market participants have different reasons for trading. In commodities, large commercial entities’ trading is largely (though not exclusively) for hedging purposes. For example, commodity trading firms hedging the price risk of oil inventories or oil producers hedging the prices of their anticipated production are important market participants. Large banks (swap dealers) also use futures markets to hedge the exposure they incur when providing over-the-counter hedging instruments (e.g., swaps) to their clients (which could include firms like the oil producer just mentioned). Speculators now typically consist of large institutions, including hedge funds, family offices, commodity trading advisors, and financial institutions. In addition to large commercial and institutional entities, smaller entities such as individual retail traders also participate in the futures market.

Although imperfect for a variety of reasons, the Commitment of Trader (“COT”) Reports produced weekly by the US Commodity Futures Trading Commission (“CFTC”) provide a useful breakdown of futures trading activity by type of trader. These COT reports disclose the quantity of contracts held by several categories of traders, including Producer, Merchant, Processor, and User (“PMPU”); Swap Dealer; Managed Money; Reporting Traders[9] who do not fall in one of the previous categories; and non-Reporting Traders. Moreover, the COT breaks down positions by long and short, and in the case of Swap Dealers, Managed Money, and Reporting Traders, by spread positions as well (something I discuss further below).

Table 1 reports the shares for long positions for six major commodity futures contracts, and Table 2 does the same for short positions.[10] The main takeaway is that large entities dominate, with small traders holding 5 percent or less of the positions in all of the commodities except corn. Thus, the main function of the traditional futures markets is risk transfer among large commercial and financial entities. This is an important fact when considering the potential role and impact of commodity perpetual futures.

Table 1

Contract	PMPU	SwapDealers	ManagedMoney	OtherRpt	NonRpt
COFFEE C	21.84	12.78	29.90	7.03	5.35
CORN	25.11	16.48	14.83	8.53	8.19
COTTON NO. 2	23.28	21.09	13.43	13.40	4.99
NAT GAS ICE	49.44	8.49	13.77	3.48	0.60
NAT GAS NYMEX	13.40	10.33	12.06	3.39	3.57
WT PHYSICAL NYMEX	32.43	3.25	9.12	7.18	3.64

Table 2

Contract	PMPU	SwapDealers	ManagedMoney	OtherRpt	NonRpt
COFFEE C	41.49	20.52	4.70	6.23	3.97
CORN	41.79	1.09	15.14	4.60	10.50
COTTON NO. 2	24.84	4.45	35.12	6.66	5.14
NAT GAS ICE	24.59	48.51	0.77	1.62	0.29
NAT GAS NYMEX	15.31	2.37	13.21	9.25	2.62
WT PHYSICAL NYMEX	18.70	25.56	4.93	3.63	2.80

The Economic Role of Commodity Perpetual Futures

The structure of perpetual futures means that they are not well-suited to achieve the purposes of futures markets described above, at least for a very large proportion of market participants. Specifically, they are not useful to large commercial hedgers or large speculators (i.e., those supplying risk capital to the market). Instead, they are most suitable for small speculators. In servicing this niche, perpetual futures might undermine the price discovery function of established futures markets.

The most telling indication of perpetual futures’ trader clientele is contract size. The Hyperliquid WTI Crude Oil contract (linked to the CME Crude Oil Futures price) is for one barrel of crude oil, in contrast to the standard CME contract which is for 1,000 barrels. The CME offers smaller contracts, and these are explicitly focused on the retail segment of the market. [11]

Such small contract sizes are impractical for large hedgers, who often hold positions in the millions of barrels. For example, in 2025, the average PMPU long in Crude Oil Futures held a position of 10.3 million barrels, and the average PMPU short’s position was 5.5 million barrels.

These average positions dwarf the entire open interest and volume of the Hyperliquid contract. On the day of the writing of this, Hyperliquid’s Crude Oil 24 hour volume in its 20x leverage contract was a mere 1.03 million barrels, and open interest only 2.13 million barrels. Volumes and open interest for other Hyperliquid commodity contracts is similarly de minimis compared to commercial position sizes.

The very nature of perpetual futures also makes them ill-suited for commercial hedging. They are designed to track a proxy for commodity spot prices—the nearby futures price—but hedgers typically are not hedging spot exposures. Instead, they hedge specific production, inventory, transportation, or consumption commitments occurring at identifiable future dates. A producer expecting to market crude oil six months hence typically hedges using contracts maturing near the anticipated production date. A grain elevator holding inventories evaluates storage opportunities by comparing prices across delivery months.

This relates directly to an important feature of commodity futures markets that distinguishes them from financial futures: the fact that there is trading for numerous contract expiration dates, sometimes stretching years into the future. Although trading volume and open interest is largest for nearby contracts, trading volume and open interest for deferred months is material.

This is reflected in the fact that “calendar spread” trading is extremely active in commodity futures markets.[12] This is illustrated in Table 3, which shows the fraction of open interest accounted for by calendar spread trades in the five contracts analyzed above. These shares are very large. By design, perpetual futures cannot accommodate spread trades. Thus, they are of limited utility to the large numbers of swap dealers and managed money firms who trade large volumes of spreads.[13]

Table 3

Contract	SwapDealer	ManagedMoney
COFFEE C	517	834
CORN	1450	2026
COTTON NO. 2	1110	1516
NAT GAS ICE	27172	17902
NAT GAS NYMEX	4682	5929
WT PHYSICAL NYMEX	10284	5480

The auto-rolling feature of perpetual futures is also attractive to small retail traders. This feature reduces transactions costs: a trader can hold a position in the nearby without incurring the commissions and liquidity costs associated with making offsetting trades in an expiring and first deferred contract.

It bears noting that the auto-rolling feature of perpetual futures does impact the timing of cash flows as compared to a strategy of successively rolling conventional futures contracts. It is well known that the cumulative payoff to a collateralized position in the nearby contract that is rolled periodically equals the change in the spot price (measured by the nearby price) of a commodity from the date the strategy is initiated to the date it is terminated. A perpetual future generates the same payoff over an identical holding period. However, with a conventional rolling strategy, the cash flows at the time of the roll do not depend on the difference (spread) between the nearby and first-deferred contracts at the time of the roll, whereas the cash flow on a perpetual future does. As noted above, the perpetual price at the time of the roll is a function of both the nearby and first-deferred prices, and thus depends on the spread between them. If calendar spreads are large, that is, the market is in a large backwardation or contango, the perpetual price can change dramatically over the roll interval even if the underlying futures prices do not change.

This has important implications for margining and auto-liquidation. Auto-roll during a period of large backwardation or contango generates large perpetual price changes, which in turn generates large mark-to-market gains and losses, and large adjustments to margin balances. Since such changes can trigger equity shortfalls (especially in high-leverage perpetual futures), they can also trigger automatic liquidations even if the underlying futures prices change little. This is not the case for conventional futures.

In sum, perpetual futures are most attractive to retail traders, rather than the large commercial and financial firms that dominate conventional futures markets. This means that perpetual futures are competing for only a relatively small share of traditional exchanges’ customer base.

However, this could have implications for price discovery. The foregoing suggests that perpetual futures will fragment/segment order flow in much the same way as dark pools, payment for order flow, and other off-exchange trading mechanisms do in equity markets.

Since retail order flow is unlikely to be privately informed, such segmentation changes the composition of order flow in ways that can impede price discovery. Although at first blush it may seem that stripping out uninformed order flow should make futures prices more informative, the opposite is true. The subfield of finance known as “market microstructure” shows that informed traders trade less intensively when uninformed order flow declines. Therefore, such declines tend to reduce the informativeness of prices, i.e., to degrade price discovery.

The importance of this cannot be predicted with any certainty, especially given the recentness of the development of perpetual futures, but some factors can be identified. One factor is whether perpetual futures will primarily divert retail traders from traditional exchanges, or will instead attract new traders who would not otherwise trade on such exchanges. The larger the importance of diversion vs. attraction the bigger the adverse impact on price discovery. But if the main effect of perpetual futures is to attract new participants to the markets (due for instance to small contract sizes, or lower commission and account setup and maintenance costs), the effect on incumbent exchanges and price discovery on them will be modest. To the extent that diversion does occur, the relatively modest shares of trading accounted for by retail traders will limit the impact on price discovery.

Summary

Perpetual futures are the new hot thing in commodity markets. They have achieved prominence lately primarily due to a surge in oil perpetual futures trading during the Iran War. This attention exaggerates their importance, and their likely future place in the commodity derivatives landscape.

Why? Because their very design makes them unsuited for hedging of commodity price risk, which is the primary function of commodity derivatives markets. Specifically, by design perpetual futures track a spot price (or in commodities, a proxy for the spot price), but commercial hedgers are primarily exposed to price risks further out on the forward curve. Moreover, calendar spread trading is important in commodity derivatives markets, and spot-focused perpetual futures cannot support such trading. Moreover, existing perpetual futures contracts are far smaller than the contracts that are traded in large volumes on traditional exchanges.

Thus, perpetual futures are tailored to a specific clientele—small “retail” traders who account for a relatively small share of traditional exchange volumes. Although perpetual futures may divert some of this volume from traditional exchanges, they may also facilitate the entry of new traders who would not trade on traditional exchanges. The ultimate competitive effect, and the impact of perpetual futures on the performance of commodity derivatives markets, will depend on the relative importance of these two effects.

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[1] Will Canny and Al Boost, Iran war volatility is driving oil trading boom on Hyperliquid, says JP Morgan. CoinDesk (20 March 2026).

[2] I offer no analysis or opinions regarding the legal status of perpetual futures under the Commodity Exchange Act.

[3] “Perpetual Futures and the Illusion They Were Built to Escape.” John Lotian News, 22 June 2026.

[4] See https://hyperliquid.gitbook.io/hyperliquid-docs/trading/liquidations for a detailed description of the process. The exchange can profit or lose by trading out of the positions taken into the liquidation vault.

[5] Some perpetual futures exchanges do not first attempt to liquidate the position in the open market, but internalize all liquidations.

[6] Below I discuss how the nature of commodity perpetual futures can inherently lead to large price changes during “roll” periods even when underlying market prices are not volatile.

[7] I focus on Hyperliquid because its public disclosures of its methodologies and trading protocols are the most complete and detailed.

[8] This procedure mimics that of some commodity futures exchange traded funds.

[9] Each futures contract has a reporting level. Those holding positions in excess of the reporting level must report them.  Those whose positions fall below the level are not required to report.

[10] The numbers do not sum to 100 percent due to the exclusion of calendar spread positions. Due to their importance, I discuss calendar spread positions separately below.

[11] The CME also offers a “mini” contract for 500 barrels, and a “micro” contract for 100 barrels. The CME has recently announced it will launch a 10 barrel contract. See Financial Times, Oil market opens up as retail traders pour in (4 July 2026).

[12] A calendar spread trade involves simultaneous purchase and sale of futures contracts on the same underlying commodity but with different delivery dates. For example, in natural gas, a February-March calendar spread purchase involves buying a February contract and simultaneously selling a March contract.

[13] Commercial traders in the PMPU category also trade spreads in large volumes, and hold large spread positions, even though the COT reports do not report such positions.

A week ago Friday (10/10/25) there was a crypto crash. Not huge, but not small. Bitcoin:

Ether was also hit.

The proximate cause was the most recent Trump tariff spasm. But that was just the spark. The initial down move triggered classical self-reinforcing crash dynamics. And the crypto market structure is arguably uniquely vulnerable to such events.

As I’ve written for years and years, (a) tightly coupled systems are vulnerable to catastrophic collapse, and (b) a wide variety of factors produce tight coupling in these markets. The most important of these factors is marking to market and variation margin.

And this dynamic is particular fraught in crypto. Positions are marked to market at a very high frequency. Moreover, the resulting margin calls occur at the same frequency. That frequency is so high that margin breaches result in liquidations of positions (“auto liquidations”) because there is no time to replenish collateral. These liquidations exacerbate price movements, creating a positive feedback mechanism–and positive feedback is almost always a bad thing in financial markets.

But it gets better! Risky positions are sometimes collateralized with . . . risky collateral! Specifically so-called “stablecoins.” I say “so-called” because stability is aspirational rather than real, especially for a new variety of “stablecoins” implicated in the 10/10 event, like USDe.

Whereas traditional stablecoins like Tether are supposedly backed by high quality, low-risk dollar assets (and the recent “Genius Act” will reduce any uncertainty about that), USDe is “backed” by both dollar assets and–wait for it–crypto. So what is the lithium that keeps USDe “stable”? Hedging using perpetual futures.

No. Seriously. Yeah, because hedges are always perfect, right? Here’s the only perfect hedge I’m aware of:

So in reality the “stablecoin” has basis risk, the basis being the difference between the price of the crypto collateral and the perp futures.

Arbitrage is supposed to keep the basis small with little volatility. However, if you look at data, e.g., the spread between BTC and BTC perp futures on Coinbase, you will see that there are frequent and large basis movements, often as big as 1 percent.

Moreover, USDe is traded on multiple exchanges, and the prices can diverge. Again, arbitrage is supposed to keep those divergences small and of short duration, but the market moves faster than arbitrage: given the frequent revaluing of positions and collateral, even a very brief price divergence can trigger a self-reinforcing spiral before arbitrage can close the gap.

On 10/10, Coinbase used the price of USDe on its platform to market collateral to market. But that exchange is not the primary USDe platform, and is therefore relatively illiquid. So forced liquidations of positions on Coinbase due to the price move and marking to market led to liquidations of USDe collateral which pushed downward pressure on the Coinbase USDe price which led to more positions being undercollateralized which led to those positions being liquidated. And this all happened faster than the speed of arb. Rinse, wash, repeat.

Can you say wrong-way risk? I knew you could.

The industry cope is to say “well ackshually if Coinbase had used the USDe price on more liquid exchanges as its USDe ‘oracle’ this wouldn’t have happened.”

Maybe. But irrelevant. What happened on 10/10 was a “normal accident.” Normal accidents result from a sequence of events in a tightly coupled. complex system. Accidents are “normal” in such systems because there are many, many, many possible sequences that can trigger accidents. Meaning that even if this particular sequence is eliminated by referencing prices from the most liquid exchange, many, many, many other such sequences will remain.

The underlying “cause” of such events is the very nature of the system itself. The reason crypto is particularly susceptible is the tight coupling due to frequent marking to market and high leverage. Those factors remain.

The crypto system is acutely vulnerable due to another structural factor–the fragmentation of trading. As I’ve frequently written, crypto market structure is puzzling. The centripetal force of liquidity typically results in the concentration of trading on a single platform. Crypto, in contrast, is traded on multiple exchanges, with several have a fairly large market share.

This fragmentation increases the number of connections and therefore the number of possible paths by which a destabilizing shock can spread. And referencing prices from other exchanges to value positions or collateral on a given exchange creates more such interconnections.

In brief, a shock–a price shock, or an operational shock–on one exchange can impact other exchanges. These shocks can trigger the destabilizing auto liquidations.

“Too big to fail” is not the right description of the crypto market. Instead, “too interconnected and tightly coupled and complex to succeed” is more accurate.

It must also be noted that the factors that make the crypto market systemically fragile make it unduly susceptible to manipulation which can in turn trigger systemic crises.

One of the oldest strategies in the book is “gunning the stops.” The play being that if you force prices to hit stops order triggers, that will induce trades that move prices further in the same direction.

In crypto, the game is “gunning the liquidations.” The idea is the same. Trade like a whale to push the price in a particular direction. If the move is big enough, that will trigger liquidations that move the price further in that direction. And since some collateral is risky, there is another way to manipulate–bash the collateral.

Given the high leverage and high frequency marking to market, the necessary push isn’t that big–maybe a dolphin can do it. And as shown on 10/10, and as discussed above, once the price moves begin they can trigger a crash.

It is also disturbing that crypto exchanges can profit from liquidations. Conceivably this could provide an incentive for the exchanges to manipulate themselves. But even if that’s not the case, the fact that they can profit from destabilizing manipulations, and instability generally, means that they have a weaker incentive, and perhaps a positive disincentive, to prevent/deter manipulations or big price moves.

In sum, crypto market structure is crapto. It has all of the inherent vulnerabilities of markets, but on meth. Supposed “innovations”–like near continuous marking to market and unstablecoin collateral–exacerbate these vulnerabilities. As does the fragmentation.

All meaning that it is inevitable that you will see this movie again.

Odd Lots was in Chicago last week, and after interviewing Don Wilson they interviewed CME CEO Terry Duffy. The interview was posted today.

CME's Terry Duffy touts its partnership with FanDuel. What CME will offer is basically what bucket shops offered back in the day. The irony is that back then bucket shops were the betes noire of exchanges. https://t.co/Z34P89KDJZ

— streetwiseprof (@streetwiseprof) October 2, 2025

I’ll get to the FanDuel tie-up in a bit, but first I want to discuss something else that came up–perpetual futures, which are a hot topic now (even though hot topic is not punk rock). Duffy cast doubt on the feasibility of perpetual futures in most CME products–he mentioned ags specifically. I agree with his conclusion but not his reasoning.

Duffy argues that perpfuts can’t work for commodities because they don’t fit the legal definition of a futures contract, which involves pricing something for delivery at a later date. He also argues that it can’t work for deliverables.

Maybe perfuts check the legal box, maybe they don’t. Twirling my Oliver Wendell Holmes-esque mustache, I could come up with a clever legal argument that based on the way perpfuts work, they are pricing a commodity at the time of the next marking-to-market, say an hour from now. Or a minute from now. Which would be in the future, either way.

And that marking-to-market is the real reason commodity perpfuts won’t work. Take the case of Bitcoin. Bitcoin perpetuals involve periodic (usually hourly) “funding payments” based on the difference between the futures price and the reference spot price taken from an exchange like Coinbase or Bitstamp. Basically cash settlement on an hourly frequency. But the contract remains live after each settlement.

So basically, a perpfut it is a perpetually (automatically) rolling cash-settled one hour futures contract. The advantages of the future over trading the spot are (a) embedded leverage, often 100-to-1, and (b) the ability to short without borrowing the underlying. Perpfuts are like trading spot, but with leverage.

This works for things for which there is a liquid reference spot market. Bitcoin and some other cryptos have that.

You could do this with say the S&P 500 because there is a large, liquid, continuously traded, transparent cash/spot market. You could do it with currencies, and via its FX Spot+ (“Rolling spot”) contract, the CME (via its EBS subsidiary) is doing just that.

You can’t do it with most commodities because there are no liquid, continuously traded, transparent cash/spot markets. Not in grains. Not in oil or other energy products (with the possible exceptions of natural gas and power). Not likely in precious metals–there is RTC trading in gold, but it is bilateral and there is no transparent pricing. Maybe you could do it with LME non-ferrous metals, because of their unique “cash” pricing mechanism.

So it’s not legal obstacles or deliverability that preclude perpetual futures in most (if not all) physical commodities. It’s the lack of a reliable spot pricing mechanism that can tie the futures and cash/spot prices together as perps are intended to do.

This is basically a special case of why I have ridiculed proposals for cash settlement in commodities for over 30 years. It’s only that the problem is even more pronounced for perpfuts because you need to observe spot prices with metronomic regularity every day, not just around contract expirations.

Turning to CME and FanDuel, my X post basically says it all. It is hilarious to me that CME is offering “event contracts” that are indistinguishable from the kinds of bets one could make on bucket shops back in the bad old days. Duffy describes contracts like “will the price of gold be above X an hour from now?” (NB: if that’s a futures contract, as Duffy claims it is, then perpfuts are no different: see above). The contracts would be “digital” (i.e, have a fixed positive payoff if the event happens, zero payoff if it doesn’t).

Well, that’s exactly the kind of thing bucket shops traded back in the day. (0dte options, which are also a thing now on many exchanges, are also very similar to old-school bucket shot bets). Exactly like them.

That’s an 1892 painting of a bucketshop. Note the use of the high tech chalkboard app.

So why hilarious? Because exchanges waged war on bucket shops for decades in the late-19th and early-20th centuries. A journal article provides some color:

On the morning of August 29, 1887, Abner Wright, president of the Chicago Board of Trade, forcibly removed the instruments of the Postal Telegraph and the Baltimore and Ohio Telegraph companies from the floor of the exchange, literally throwing their equipment out of the building. A few months later, on the night of December 15, Wright discovered some mysterious electrical cables leading out of the basement of the exchange building. Thinking that they were telegraph lines, he ordered them cut with an axe. Instead, they were cables connecting the building to the police and fire departments.¹ His desire to sever the Board of Trade’s telegraph connections might seem surprising, since the telegraph network was indispensable to the operations of the major stock and commodity exchanges.

That’s why the CME’s current move is hilarious. If you can’t beat ’em, join ’em.

I’m not censorious of bucket shops per se. People gonna gamble. The CBOT’s (and NYSE’s and other exchanges’) ire reflected not a moral judgment, but a dislike of competition. (Yes you can make arguments like Mulherin, Netter and Overdahl that the shops free rode on the price discovery of exchanges, and that impaired liquidity. But as I’ve shown in my academic work, this “free riding” can actually enhance efficiency if exchanges have market power, which they almost certainly do).

Exchanges today almost certainly realize that they can’t drive bucket shops, excuse me, betting apps, out of business: Terry Duffy can’t forcibly remove their equipment, a la his distant predecessor Abner Wright. So the best alternative is to get in the game with them.

Perfectly reasonable commercial strategy, but a deeply ironic one.

SEC Chairman Paul Atkins has clearly set out to be the anti-Gary Gensler. If that’s not an endorsement, I don’t know what is!

Case in point–his move to abandon to the mercies of the courts Gensler’s cretinous, pointless, and incredibly burdensome climate reporting rule. (I use that Sierra Club link to provide some levity. I love the smell of hysterical panic in the morning).

Atkins is also largely reversing GiGi’s anti-crypto agenda. (Well, he is a “crypto peddler” after all, at least according to the Sierra Club!) I am not a crypto evangelist by any means, but broadly support letting consenting adults trade what they want to trade. The regulatory framework for such trading should focus on legitimate investor protection, anti-fraud, and anti-manipulation measures as set out in the SEC’s authorizing statutes. That’s what Atkins’ SEC is striving to do, in contrast to Gensler’s mission to strangle crypto at every opportunity.

In crypto, but more generally, Atkins is also moving sharply away from Gensler’s regulation by enforcement approach, which is another welcome change.

And hot off the presses, Atkins has taken aim at the bloated and (IMO) pointless Consolidated Audit Trail. (Seriously–I found the above announcement while Googling “Atkins CAT” while writing this post. It came out hours before I put pixels to screen). Proposed in the aftermath of the 2010 Flash Crash, it always struck me as a hugely expensive solution to a non-existent problem. Yes, the CAT could assist in forensic evaluations of market events like the Flash Crash and market manipulation, but having worked on such evaluations in markets lacking the CAT, and reading the analyses of others, I conclude it is possible to carry out these analyses without CAT. Put differently, the marginal benefit of the CAT is minuscule relative to the cost.

One issue that has received less attention outside the equity trading community is market structure, and particularly RegNMS. The 20th anniversary of that regulation was the occasion for an SEC conference to reevaluate that regulation. (At the time of the passage of RegNMS, I wrote an article saying that it marked the 30 Years War over market structure that began with the 1975 Securities Act, and wryly suggested that there would actually be a 100 Years War over market structure. We are now at the halfway mark!)

Along with several participants, Atkins criticized a key provision of RegNMS–the so-called “trade through rule” that prevents the execution of a trade on one exchange when a better price is displayed on another. Atkins favors elimination of the rule.

This rule is the keystone of RegNMS, and its removal would reshape the equity exchange environment as thoroughly as the regulation did 20 years ago. Indeed, its elimination would signal that the entire experiment was ill-conceived.

As I wrote in my Regulation Magazine piece, the trade through rule was the “centerpiece” of RegNMS. Its very purpose was to cause a fundamental restructuring of equity trading in the US. And it did.

As I phrased it, the purpose of the rule was to “socialize order flow.” That is, eliminate–or at least sharply circumscribe–the control that an exchange had over the order flow directed to it. The objective of this was to make the exchange landscape more competitive, and specifically to reduce the market power of the NYSE and NASDAQ. At the time of RegNMS’s passage, the NYSE executed 80 percent of the volume of shares listed on it.

Evaluated against its stated objective, RegNMS was a . . .

The equity trading landscape looks nothing like it did in 2005 or before. More than half of trades are executed off exchange. The remainder is divided among 12 exchanges, with the largest having a 10 percent market share:

But to Atkins and the critics of the trade through rule, this represents not great success, but great failure. To the critics, this fragmentation is deleterious.

That is, one man’s competition is another man’s fragmentation.

The post-RegNMS environment has clearly seen dramatic improvements in liquidity and declines in trading costs. This is plausibly, though not definitively, materially the result of increased competition. Moreover, the exchanges have adopted different order types, pricing rules (e.g., taker-maker/inverted v. maker-taker), and trading infrastructures. This means that heterogeneous market participants can choose among heterogeneous platforms, thereby achieving a better match than a one-size-fits-all system would.

The main disadvantage of fragmentation–and a major source of discontent–is that brokers and traders must connect to a variety of platforms, and crucially, must buy data from each. As I wrote some years ago, this creates strong complementarity among the data streams that exchanges provide, which as Cournot demonstrated two centuries ago creates considerable market power which inflates prices. Data is expensive, and economics implies it is too expensive.

What would happen if the trade through rule is abolished? I predict that by effectively re-privatizing order flow it would lead to a massive consolidation of trading venues, and a return to a market structure resembling that of 2004 and before. Less fragmentation, but less competition. Those are essentially two sides of the same coin.

The busy Mr. Atkins has also weighed in on the issue of the frequency of corporate reporting, favoring (fast-tracking, actually) the elimination of the quarterly reporting requirement. Since Trump proposed the same, of course this has led to shrieks and wails–which have been markedly absent when Warren Buffet mooted the idea.

Here’s another issue where I support letting the market decide, as is typically the case when there are trade-offs. Reporting frequency has costs and benefits. A company that provides too little information largely internalizes the cost, in the form of a lower stock price. That is to say, its shareholders internalize the cost. Yes, agency problems mean that managers who make disclosure decisions may act against the interest of shareholders and disclose too little or too infrequently, but that is a problem that is inherent in the corporate form (and the consequent “separation of ownership and control”) that manifests itself in many ways that are not the subject of government mandates and intricate regulations. It’s hard to see why corporate disclosure should be different. Yes, punish false disclosures, but don’t dictate how often companies must avoid lying.

One concern in recent years has been the large number of companies deciding to go private or remain private (rather than IPO’ing). There are myriad reasons companies make these choices, but one of them is the cost of being subject to the reporting obligations imposed on public companies. Easing those obligations somewhat would nudge more companies toward going/remaining public, meaning that the amount of information available to investors and the opportunities available to them might increase if the Trump/Atkins proposal goes into effect.

Overall, Atkins is a welcome relief. Though anyone probably would have been, after Gensler’s Reign of Error (and Terror). I’m ambivalent about his hostility to the trade through rule, but on non-market structure matters he is moving in the right–and pro-market–direction.

Today’s Bloomberg Odd Lots has an interesting conversation with Don Wilson, founder of DRW whom Odd Lots calls the “King of Chicago Trading.”

Overall the ~40 minute conversation was very interesting. One of the most interesting parts related to the possibility of GPU futures trading. Wilson thinks it could become the world’s biggest market, and is putting his money where his mouth is. This includes the creation of GPU price indices.

I’m pretty skeptical on the prospects for this market. I note at the outset that it is very difficult to predict which futures contracts will succeed, and which will not. Most don’t.

In a nutshell, the necessary conditions for a successful futures contract are pretty well established. The underlying market must be large. The price of the underlying must be volatile. The underlying can be heterogeneous, but not too heterogeneous, otherwise basis risk is too big with any single contract, and no single contract can generate enough volume to be viable.

GPU would certainly tick the market size box. Perhaps the volatility box. The heterogeneity box–not so sure, although trading a contract that prices based on a service flow (e.g., flops) rather than chips themselves would probably tick that box as well.

Although the necessary conditions for a successful contract are pretty well established, sufficient conditions are not. One can launch a futures contract on something volatile with a large underlying and price volatility and watch it flop. That happens quite frequently.

What’s missing from most analyses, in my view, are more qualitative things. The most notable of these is market structure. In particular long marketing chains, with a lot of intermediation. Also, relatively low concentration on either the producer or the consumer side.

In commodities, for example, trading firms generate a lot of the hedging activity. They intermediate the flow of the physical, and typically their exposures turn over relatively rapidly, meaning that they are putting on and taking off positions frequently. This generates trading volume and liquidity.

The fragmentation of the value chain and fundamental volatility militate against long term contracts for most commodities. Moreover, the lack of concentration mitigates market power which is often associated with price rigidity (as Dennis Carlton showed many moons ago).

My understanding of the GPU market is that the marketing chains are short, not intermediated, and highly concentrated. For example, there are a small number of very large cloud storage providers. AI is likely to be highly concentrated on the buy side. The GPU production side is obviously very concentrated, being dominated by NVIDIA.

Moreover, transactions cost considerations are likely to lead to a good deal of vertical integration. AI firms are going to buy their own chips. Vertical integration also militates against the development of a liquid futures market.

Given the concentration on both sides of the market, I anticipate that to the extent buyers and sellers want to achieve some price stability, it will be via bilateral contracts between the producers and the big users.

Joe Weisenthal asked the question that came to my mind–what about DRAM futures, which were highly touted at the height of the dotcom boom, and crashed along with NASDAQ in 2000?

I have some personal history here. One of the (many) nascent DRAM futures markets (Buckaroo.com, if you are wondering) flew me out to Mountain View to give my opinion on the prospects for the market. Ironically, I was there the day NASDAQ crashed. (Hmmm, I also had some connection with the ’87 Crash–maybe it’s me!)

My assessment was negative. Not long after, the late CEO of Micron, Steve Appleton had me come out to Boise to give my view. Buckaroo had been importuning him, and when they told him they had talked to me, he invited me to tell him what I had told them. After hearing my take, he told Buckaroo “hard pass.”

My prediction, vindicated by experience, was based on market structure considerations. My skepticism about GPU futures is similarly grounded.

For his part, Wilson dismissed DRAM as a precedent. In his view, the fact that DRAM prices trend down strongly meant that there was no underlying volatility to hedge or trade around.

I don’t find that compelling. Yes, everybody knew that prices for a particular chip type tended to trend down (due mainly to learning-by-doing). But as long as there is variation around that trend, there is a price risk that sellers and/or buyers might want to hedge.

DRAM might not be the only cautionary tale. I’m so old I remember Enron touting bandwidth as the future world’s biggest commodity. Yeah. No.

Another issue is information flow. A high rate of information flow causes high rates of price changes which drive both hedging and speculation. Weather derivatives tick a lot of the necessary condition boxes, but information flow is very lumpy. Consider a weather derivative on July 2026 cooling degree days in Houston. From now until, oh late-June–maybe–there will be relatively little information that flows. So there’s nothing really to trade on until then. Meaning that volumes–and liquidity–will be moribund.

Which is why exchange-traded weather derivatives have never done any real volume.

My intuition is that the information flow about future DRAM value will be pretty modest.

So maybe GPUs will be unlike DRAM and bandwidth and weather, maybe it won’t. I will watch with interest.

Another interesting part of the Odd Lots conversation related to the CME’s move to the cloud. Wilson made the great point that the way the cloud works is not compatible with housing the matching engine there. Especially in a high speed world, it is nigh on impossible to implement time priority on the cloud.

Wilson, Alloway, and Weisenthal also discussed tokenization. Here I agree that this could become a thing, and a big one. It may finally be the moment for DLT/blockchain technology to have a big impact.

It was widely hyped for years as transformative, for everything–including financial markets and commodity markets. I had a 2022 JACF paper expressing skepticism about the potential of DLT/blockchain. I still am skeptical about a lot of the proposed uses (e.g., tokenizing shares of fine art or real estate, or in physical commodity trading). However, tokenizing standard securities, derivatives, or collateral offers some advantages. Like I wrote in the 2022 piece, the interesting thing to watch will be whether the blockchains will be permissioned or public.

Some tokenized ETFs and MFAs trade on permissioned chains, but some are on Ether. In 2022 my intuition was that most trading applications would be via permissioned blockchains, but now I’m not so sure. I’ll revisit that issue as time allows me to get more up to speed on what is going on.

A jury in a class action lawsuit filed by a group of Class B shareholders (ex-floor traders) found in favor of defendant CME Group. The suit claimed that the CME had breached its contract with the would-be Killer Bs, most notably by opening the Aurora Data Center (“ADC”) and providing access to it to non-Class B shareholders. As the Court (Judge Patrick J. Sherlock) summarized it, according to the plaintiffs

the [ADC] is a trading floor within the meaning of the [Class B Shareholder’s] Core Right 2–hence, only members are eligible to exercise trading righs and privileges at the ADC. The CME Class contends that the defendants breached their Core Rights by (a) allowing non-members to trade CME products from the ADCO trading floor, (b) requiring Clas Be members to pay co-location fees from the ADC, and (c collected co-location fees from market participants without sharing them pursuant to the revenue sharing plan with members

The CME Class also contends that defendants breached their contractual rights by allowing non-members to trade at member rates, providing discounts and special rates to large customers that are better than rates available to members, and charging co-location fees to CME Class members by eliminating the benefits of the CME fee schedule.

I can’t say that the verdict was a surprise, mainly because anything can happen in a trial, especially one with a jury. Which is precisely why such large cases never make it to trial.

Although I did not hear all the testimony based on the original complaint and the record in the case (notably rulings on the motion to dismiss and summary judgment) I think that the verdict is correct. There is a yawning gap between specific facts alleged in the complaint and far broader inferences drawn therefrom.

The complaint relies heavily on quotes from Leo Melamed’s book, For Crying Out Loud: this makes for good atmospherics, but it hardly qualifies as a contractual commitment. It also contains a few facts relating to the Core Rights established under the CME demutualization plan. It then draws inferences from these that are, in my opinion, far too broad and unsupported.

It is clear that the Core Rights were focused primarily on protecting the CME floor. This was essential to get the member’s support for demutualization. Section Three of the article related to Class B Shareholders in the revised Certificate of Incorporation that formalized the demutalization is labeled, in all caps, COMMITMENT TO MAINTAIN FLOOR TRADING. It lays out various volume metrics which if met, precluded the exchange from terminating floor trading in a contract.

The CME rules at the time also provided members (who became Class Bs) “GLOBEX Screen Rights” (emphasis added for a reason that will become clear shortly), and guaranteed Class B shareholders would have access to the GLOBEX2 trading system and definted eligibility requirements for access to a GLOBEX terminal. The complaint also quotes Melamed committing that Class B shareholder clearing fees would never be higher than the clearing fees charged others.

And here’s where the yawning inferential gap appears. From these facts, the plaintiffs claim that in demutualizing the CME gave the Class B shareholders the “Right to Best Access and Closest Proximity to the Globex Platform, and to Allow the Class B Plaintiffs to Share in Globex-Related Revenues.” Not from the facts in the complaint, it didn’t.

Granting Class B shareholders the right to trade on Globex did not, when evaluated on the face of it, give them exclusive access. Nor did it give them “best access and closest proximity” under all future technological improvements to Globex. It gave them access. Via terminals (screens).

The plaintiffs attempted to argue that ackshually post-ADC, Globex was the floor, and since they had exclusive access rights to the floor (and nobody else did), they had a right to Globex on the best possible and exclusive terms under all technological conditions. They claim, based on a quote from Melamed, that since “ultimately electronic trade would become the real ‘price-discovery pit'” therefore Globex was a “virtual trading floor.” Since they had exclusive rights to the meatware trading floor, they had rights to the virtual trading floor. QED!

Nice try, but no cigar. The fulsome description of the commitments that the CME made to maintain the floor makes it abundantly clear that, within the four corners of the contract that the plaintiffs claim the CME breached, the floor was, well, the floor. Those cavernous spaces on South Wacker, not a large air conditioned building filled with humming servers.

The contract did not provide exclusive access to the locus of price discovery, whatever that turned out to be, floor, Globex, or mental telepathy. By the understanding of everybody at the time, the floor was the place where guys traded futures contracts and futures options by screaming and making funny hand gestures.

In sum, taking the allegations in the complaint as true, the CME promised to provide access to Globex to the Class B members. It did provide access to Globex, and continued to do so. It did not promise to provide “best and most proximate access” to any trading platform the CME introduced up to the end of time. That’s an assertion made by the plaintiffs that is not supported by actual evidence.

After a major technological revolution, the CME provided a new type of access–co-location, with higher fees for shorter cables. In my view, the plaintiffs made a completely unsupported, an extremely large, logical leap to assert that the access rights granted with demutualization necessarily conferred preferential access rights to the new technology.

And technological change is the crucial issue here. What this all comes down to is a failure of imagination by all concerned–including Leo Melamed. Specifically, a failure to imagine the emergence of HFT, and algorithmic trading generally. Trading that was not only not face-to-face, but was untouched by human hands via keyboard, mouse, or touch screen.

At the time of demutualiztion, computerized trading was screen trading–and it was often referred to as such. Indeed, even by the standards of screen trading as it became, 1999-era computerized trading was cumbersome. Not until TT screens were introduced (along with copycat products) in the early-2000s did screen trading become user friendly and fast. But in the minds of virtually everyone in the industry at the time, “computerized trading” meant “a human inputting orders to a computerized limit order book via a screen/terminall/keyboard/mouse.”

I was an early and pretty lonely predictor that computerized trading would eventually displace the floor, yet I did not foresee how computerized trading would evolve. My predictions were mocked when made in the mid-1990s: when I released a study (done under the auspices of Deutsche Terminborse, later Eurex) finding that liquidity on computerized and floor markets was approximately equal, the late Robin Wigglesworth, then Chairman of LIFFE, ridiculed me on the pages of the Financial Times as an ivory tower academic who had no clue about the real world. I restrained myself from gloating (publicly, anyways) when Eurex nearly killed LIFFE in 1998, and LIFFE shut its floor and went electronic.

So it’s fair to say that I was more foresighted about computers v. floor than most, and especially most actually in the industry, when I predicted the eventual triumph of electronic trading. But my foresight was far from perfect, as I did not foresee how electronic trading itself would evolve.

In other words, a lot of history was packed into the 12 years between demutualization and the opening of the ADC. The CME responded to the technological change by introducing a new form of access that was tailored to market participants who had virtually (no pun intended!) nothing in common with the Class B shareholders. The new system catered to those who specialized in virtual markets.

If the CME had not done so, it would have breached its duties to the Class A shareholders and perhaps doomed the exchange to oblivion.

The mismatch between the human capital of the Class Bs and the heaviest users of the ADC is massive. The Class Bs did not have the skills or knowledge necesssary to produce value by trading on Globex via co-lo.

Here’s what likely would have happened if the CME had provided access on the basis the Class Bs claim they were promised. Since they could not exploit the nature of the ADC themselves–most couldn’t even make the leap to screen trading–they would have arbed by selling or leasing their access rights to those who could. Or the CME would have bought out Class B shares. And what a negotiation that would have been, given the vast difference between the value of co-location to the typical Class B and its value to the Virtus and Jumps of the world (and hence to the CME). That and the personalities of the Class Bs–personalities suited to the no-holds-barred bargaining on the floor.

In the event, CME concluded that it did not owe the Class Bs anything more than providing some access to Globex (basically on the terms shaped by 1999-2000 technology) and keeping the floor open unless and until the computers killed it. As they eventually, and arguably inevitably, did.

Class B shares did plunge post-ADC. But that’s because the real value of the Class B shares was driven by the exclusive right to access the floor, not by rights to access CME trading platforms by all means imagined or unimagined. ADC at most accelerated the demise of the floor, and recognition of that dynamic cratered the value of floor trading rights, which foreshadowed the closure of the floors (for futures and many options) a few years later.

History did not work out well for the Class Bs. Like 18th-19th century weavers, they were overwhelmed by technological change that they did not anticipate, and which was not anticipated by those who displaced them. They bargained for a demutualization deal predicated on their beliefs about computerized trading technology–as did the CME. The technology changed in ways that few if any even dreamed of. This made their deal far, far less favorable than they had anticipated. In 1999-2000 they hit their drive–right into a sand trap they didn’t see.

So they wanted a mulligan, and the lawsuit was their way of demanding one. But a jury found that they got what they were promised, and a mulligan was not among the promises.

Watch the movie Floored and you can have some sympathy for this particular group of individuals who like many before were rendered obsolete for technological change. The potential for such sympathy is why I thought a jury might find for them, despite their weak legal case. But the jury instead apparently went with the principle that a deal is a deal, even if the deal doesn’t work out they way you like.

Which, ironically–was the way the floor operated.

Cocoa has been on a wild ride for the past year.

So wild that Bloomberg has a separate category for “The Cocoa Crisis.” Contributing to the recent hysteria is news that Hershey has requested “special permission to buy over 90,000 tons of cocoa.” Evidently the chocolate manufacturer has requested a position limit exemption from the CFTC. (Links to the “Cocoa Crisis” coverage are in the article).

Note that exemptions, specifically for hedging, are explicitly recognized in the relevant regulations, and are granted routinely, so this is not really exceptional. Not knowing the exemptions granted to Hershey in the past it is difficult to know whether the magnitude of the exemption is extraordinary.

The article is confusingly written. In commodities subject to limits, there are different kinds of limits. These include single month and all month limits outside the “spot month” and “spot month” limits. Spot month limits kick in sometime prior to expiration. In cocoa, it is my understanding that the spot month limit kicks in on First Notice Day, which for the next ICE Cocoa contract (“CC”), March 2025 (“CCH5”) is 24 February, 2025.

The article implies that the exemption requested is for the spot month:

The maker of Reese’s Peanut Butter Cups wants to take a position that will allow it to purchase more than 90,000 metric tons of cocoa on ICE Futures US, said the people, who asked not to be identified because the information is private. The request to the Commodity Futures Trading Commission equates to about 5,000 20-foot containers and is more than nine times the amount the exchange currently allows.

The spot month limit is 1,000 lots, so 9,000 contracts would be 9x the spot limit. The single month/all month limit is 4,900 contracts, so the requested exemption would be less than 2x the single/all month limit.

I am somewhat skeptical that the exemption request is related to the spot month given that spot exemption requests can occur closer to FND, and the magnitude is so large relative to ICE cocoa certified stocks (currently only 1,604 lots) that granting such an exemption would be problematic. Particularly problematic would be “purchas[ing] more than 90,000 metric tons of cocoa on ICE Futures US” if that means acquiring that much physical cocoa via the delivery process.

But Hershey did that in 2020, and exchange cocoa is supposedly at a discount to the cash market. The cash market discount begs the question: why? Are apples being compared to apples in terms of quality, location, etc.?

Acquiring 90,000 tons–or 25 percent of that amount– would require bringing in large amounts of cocoa to exchange warehouses. That in turn would require acquiring cocoa on the cash market (at a supposed premium), getting it to ICE warehouses, grading it, etc. So it’s hard to believe that cert cocoa is an economical source of supply for Hershey in the quantities mentioned in the Bloomberg article.

The price movement in 2020 sure as hell looks like a squeeze, but neither ICE nor the CFTC took action, so maybe Hershey figures it can do it again.

Unlike 2020, this time the spread didn’t take off:

The March-May 2025 spread did spike in mid-December, but only narrowed slightly after the publication of the Bloomberg article on 8 January. (Perhaps somewhat confusingly, an increase in the spread is referred to as “narrowing”. “Wider” means a bigger carry: “narrower” means less carry or more backwardation).

Here’s 2020 for comparison:

I certainly believe that big commercials can sometimes bamboozle ICE and the CFTC, especially when it comes to telling just so stories about how its economical to take delivery. So it’s not inconceivable that Hershey is trying to do that here, and that they will succeed.

The are other curious things in the article. For example: “A spokesperson for the Pennsylvania-based company said Hershey has a ‘rigorous’ procurement process and that it is ‘well covered’ on its cocoa needs for 2025.” If “well covered” means that Hershey has supply contracts sufficient to meet its anticipated physical needs, why would it need to take delivery? If “well covered” means that they supply contracts are fixed price, Hershey wouldn’t need to hedge using futures. So the company’s statement obfuscates rather than informs if it is intended to ease fears that the company could be hammered by a high and rising cocoa price in 2025.

As I noted before, the epic price rally has put cocoa in the news frequently. Another example is this Reuters article from last month. In brief, the high and volatile cocoa prices have driven speculators from the market, leading to thinner, less liquid markets.

A couple of comments.

First, the exit of hedgies has not caused prices to decline, which implies that they were not the ones that caused the high prices in the first place as has been frequently claimed (as is usually the case when prices move a lot–“round up the usual suspects”).

Second, the reduction in speculative capital makes the price more sensitive to bigfooting by commercials. Like Hershey. Just sayin’.

Third, this demonstrates clearly the effects of clearing and margining. Volatility and high flat prices increase margins and thereby the cash needed to maintain positions. Since cash liquidity can be costly, this raises the cost of providing both long term and short term market liquidity, which leads to the exit of speculative capital that has occurred in cocoa. This in turn increases volatility all things equal. That is, the margining mechanism creates a positive feedback loop that can be detrimental to market performance.

Not to say that the credit risk mitigation benefits of margining don’t outweigh these market liquidity costs. Just pointing out that mitigating credit risk is not cost free.

Given the decline of liquidity and the possibility that a large commercial may lean on the delivery process, the cocoa market is worth keeping an eye on.

As an aside, some years back there were squeezes in cocoa in March. I used to teach my commodity trading course in Geneva in March, and I joked to my students that I should buy CC calendar spreads before heading to Geneva. (I now teach there in April). This March might be particularly interesting.

And of course there was the big Armajaro corner in cocoa in July 2011.

All in all, cocoa can be a source of material for those interested in how er “technical factors” affect pricing. Including me. So I guess you could say I’m coo coo for cocoa:

(A flashback to my youth).

Until I read this post by Nasdaq chief economist Phil Mackintosh I was unaware that the SEC wants stock exchanges to adopt cost-based pricing. Even by regulator standards–and Gensler-era SEC standards in particular–this pegs the Dumb-o-Meter.

It is dumb on many levels. Full spectrum dumb.

For one thing, why would the SEC want cost-based pricing? Presumably because it believes that exchange prices are too high. Why would that be? Market power presumably.

But in the electronic era, and ironically especially in the post-RegNMS era, there is substantial competition between exchanges, and between exchanges and the OTC market. Here’s a chart of trading volume and shares by venue for the last 5 days (found here).

Note that exchanges account for less than half of total volume, with a majority of trading taking place on the OTC market. Even among exchanges, volume is fairly well split, with the NYSE having the biggest share (roughly 1/3 of exchange volumes).

This volume split reflects the competition that resulted from RegNMS in an electronic environment. Given this competition, excessive exchange profits should be the least of the SEC’s worries.

Even if market power was a concern, the idea of cost-based pricing would be inane. Exchanges have fixed and variable costs. Price structures must cover both, but average cost pricing leads to inefficiencies: the price of the marginal trade should equal marginal cost, but marginal cost is virtually impossible to measure. And with fixed costs, it can be efficient to utilize variants of Ramsey Pricing in which prices deviate from marginal costs, and for multi-product firms the deviations between price and marginal cost vary by product. (Exchanges are multi-product firms, offering transaction services, data, listing, and other services). (The SEC might also want to catch up with the economics literature, starting with Coase’s The Marginal Cost Controversy, which is only 78 years old).

Moreover, as Mackintosh notes, exchanges are platforms–though he doesn’t explicitly point out the key fact that they are two sided platforms, as most matching systems are. A crude taxonomy of the two sides in the exchange context is liquidity suppliers and liquidity demanders.

As has been known since two sided platforms became a thing (post-Internet, basically) optimal platform pricing structures can be very complex, and optimal pricing structures are not cost-based. To generate the mix of customers that maximizes platform value it is typically the case that one side pays below cost prices (and may indeed pay a zero price or receive a subsidy). In the exchange context, this is most readily seen in maker-taker or taker-maker pricing structures where the exchange fee differs depending on whether you are the active or the passive side of a transaction.

One aspect of inter-exchange competition is that they compete on price structures in order to optimize platform value. Some exchanges even offer different platforms with different pricing structures. This differentiation accommodates the heterogeneity of traders, some who prefer one structure and others who prefer another. In essence, the platforms are competing for different clienteles.

The idea of imposing a cost-based cookie cutter pricing structure on exchanges is therefore beyond absurd. Not only is it unnecessary to constrain market power, any cost-based structure would be wildly inefficient and completely at odds with the basic economics of exchanges as two-sided platforms.

But I guess that’s what you should expect from an agency dominated by lawyers and accountants.

It is ironic that the SEC apparently doesn’t recognize the benefits of one of its major regulatory initiatives of the past two decades–RegNMS. That regulation led to substantial inter-exchange and inter-platform (exchange-exchange, exchange-OTC) competition. One result of that competition is non-cost-based pricing that reflects the fundamental nature of trading venues as two-sided platforms. Thus, exchange pricing is something that the SEC doesn’t have to worry its pretty little head about.

There is a bigger lesson here, relevant to our DOGE era. Parkinson’s Law says that in a bureaucracy work expands to fill the time available. An agency that has the time to pursue such daft initiatives is obviously over-resourced and over-staffed.

Put differently, idle regulator hands are the Devil’s workshop.

Apropos an earlier post scourging Tyler Cowen’s lament that cutting regulator headcount would harm businesses who rely on regulators’ guidance, there have been numerous articles appearing in the post-election days similarly arguing that regulators are really businesses’ friends. They’re from the government, and there to help you! Really!

But as I noted in that post, much of that “help” is necessary only because regulators create the need for helpers by implementing wasteful, complicated, and intricate rules. Cost-based pricing of exchange services could be a poster child for that. It would be economically unnecessary (because competition constrains pricing) and inherently result in absurdities that would have the regulated running to the regulators for guidance and clarification. Regulators creating jobs for regulators, and justifying their existence thereby.

The structure of financial market regulation has been a source of dissatisfaction since at least the time of the birth of the SEC in the 1930s, and maybe even dating back to the first regulation of futures markets in 1922. Don Wilson of DRW is only the latest of those to express this dissatisfaction.

Since derivatives markets first emerged from their niche in the commodities, and especially agricultural commodities, a lot of the criticism has focused on the bifurcated nature of US regulation, with separate securities and derivatives regulators, the SEC and the CFTC respectively. Why not just have one regulator given the substantial overlaps between securities and derivatives markets? Whereas previous “reform” proposals have been to merge the agencies, Wilson suggests scrapping them both and creating a new unified regulator.

This idea is a hardy perennial and has always struck me as mere org chart shuffling, or furniture rearranging. And that’s the best case. Worse outcomes are very possible.

For one thing, the relevant laws–the Securities and Exchange Acts, and the Commodity Exchange Act–would remain in place, with one commission in charge of implementing both. Many of the conflicts, tensions, and contradictions involving the SEC and the CFTC are rooted in the underlying laws, and would remain post-merger (or replacement with a super agency). The conflicts would become intramural rather than intermural as it were, but would not go away.

For another, I generally favor functional regulation and given the myriad functions of financial markets and institutions subsuming all regulatory oversight to a single agency may well impede functional specialization.

The SEC already represents a good example. In broad strokes the Securities Act relates to securities issuers (e.g., disclosures) and the Exchange Act relates to the trading of securities. Those are two very different functions and only tangentially related. Yet a single regulator oversees both.

The CFTC also has authority over trading per se on some venues.

Both agencies have authority over intermediaries (e.g., broker-dealers, FCMs) and clearing.

Maybe there would be some reasonable rationale for splitting off regulation of issuers from regulation of trading, trading intermediaries, and clearing, and putting these last three in a single silo. But even that is problematic due to path dependence.

We are not starting with a blank slate. The pre-existing statutory division is one historic fact. Another is that derivatives and securities markets have evolved very differently, and that could very much reflect the longstanding regulatory bifurcation.

Is it desirable to move toward uniformity in how derivatives and securities markets are organized and governed, and in essence ignore the historical process that created the current market structures? That’s not immediately obvious given how wrenching and unpredictable the process of achieving uniformity would be–and how rife the unexpected consequences would be.

Moreover, how would the political economy work? There’s no guarantee that the politics of a unified regulator would lead to a more efficient regulatory structure.

Indeed, to me it’s more likely that that rent seeking would rule, and efficiency would be damned. There’s actually a strong argument to be made that competition between regulatory agencies disciplines the rent seeking to some degree. And it can also discipline the ideological fervor of someone like Gary Gensler.

The ongoing drama over crypto regulation is an example. I’m not a crypto evangelist by any means but overall I favor letting market processes determine the outcome. If GiGi was king, or even merely the sole regulator of crypto, that would never happen. Regulatory competition (with the CFTC) constrained Gensler and the SEC, so the market will have the chance to have the final vote.

Indeed, one of Don Wilson’s beefs is very specifically with Gary Gensler. (And oh boy, do I get that!) A regulatory structure with one regulator would make some future GiGi far more dangerous.

Why should regulatory monopoly be looked upon more favorably than private monopoly? Indeed, regulatory monopoly is more dangerous because it cannot be disciplined or undermined by entry. Only the naive who believe in the public interest theory of regulation (and regulators) could believe that a single regulator would act to enhance efficiency rather than exploit its power for often malign reasons.

I have often written that there is a multitude of ways for executing financial transactions that have some common elements because transactors and transactions are heterogeneous. One size does not fit all. (Gensler was something of a one size fits all fanatic at the CFTC). Even though any division will lead to anomalies, conflicts, and regulatory arbitrage, there is enough distinctiveness between say derivatives markets on the one hand and security markets on the other to make separate regulators a better outcome. The division of labor is limited by the extent of the market. The scope of financial markets is so huge that there is considerable division of labor in them, and a division of regulatory labor makes considerable sense too.

Further, although the term “regulatory arbitrage” is typically used as a pejorative, it is not necessarily a bad thing. Indeed, it can be a good thing when market participants use regulatory fragmentation to introduce beneficial innovations that a particular regulator would prevent.

It should also not be forgotten that the SEC and the CFTC are not the only regulatory players in this game. The banking regulators and the Fed are also quite involved, especially on issues relating to intermediaries (who are banks or deeply enmeshed in the banking system) and clearing. Some regulatory fragmentation is inevitable as a result. Just mashing together the SEC and the CFTC will not make the fragmentation disappear.

I say only slightly facetiously that the best effect of regulatory consolidation is that reduced specialization would increase the cost of regulation, leading to less of it. There are no economies of scale, and are in fact diseconomies of scale, at the commissioner level. The bandwidth of the commissioners who are the final arbiters of rules is limited. As a rough estimate, a single commission responsible for double the statutes will have the capacity to produce half the rules as two commissions would. Sounds good to me!

(And no, doubling the number of commissioners would not help. Each commissioner has to weigh in on each proposed rule).

(Less factiously, doubling the workload would empower staff as commissioners would be more reliant on staff to craft rules, and explain them, so rule “output” might not decline that much as the commissioners just end up spending less time on each proposal).

Proposing agency merger or creation of a super agency is almost always a symptom of overall dissatisfaction with regulatory outcomes. But those bad outcomes are usually the result of bad regulators or bad underlying statutes. As noted above, consolidating regulators would increase the power of the bad regulators who will inevitably come along, so be careful what you ask for. And redrawing the regulatory org chart won’t address the statutory problems.

So if you don’t like current regulatory outcomes, don’t focus on the number of agencies and the names on the buildings they occupy: focus on the laws that determine what regulators can do and how they can do it.

Frankendodd was full of bad things, so start with that. Go to a slimmer legal framework that focuses on force and fraud rather than one that attempts to micromanage market macrostructure. Work towards a framework that disempowers would be Gary Genslers rather than the reverse.

Recent Supreme Court decisions, especially Loper, will help by constraining the ability of regulators to go beyond the authority explicitly delegated to regulators by statute. But many of the delegated powers are already too broad, so that needs to be addressed too.

In sum, to fix regulation it is necessary to get to its roots. Its roots are in legislation. Shuffling around who implements the legislative mandates is a superficial response to a deeper problem that originates in the Capitol.

PS. My friend Jeff Carter has a Substack on the same issue. Check it out.

Javier Blas is in a tizzy about a new ETF that will hold physical copper. He shouldn’t be.

He says:

Might the copper market suffer a similar squeeze [to the Hunt episode of 1980]? Until now, I would have been confident in saying no. But speculators are about to get an easy and completely legal way to dominate the market for the red metal — a development that regulators seem far too relaxed about.

Bloomberg

Why not worry, let alone panic? Many reasons.

First, I don’t know where Javier has been, but this is hardly a new development. There have been physical copper ETFs around for over a decade: I addressed a similar moral panic that erupted when that was introduced. There are also physical ETFs in other metals. The scare scenario has not transpired in all that time.

As I say every time I teach about speculation (as distinct from manipulation), what is necessary for it to distort prices is that it must somehow distort the physical market, that is, distort supply or demand. The doom scenario outlined (“As more money pours into the new fund, more copper will need to be stockpiled as backing”) seems to envision a distortion in supply. Specifically, uneconomically withholding stocks from the market.

First of all, that scenario assumes really dumb money. I mean really dumb. Buying shares in an ETF that will turn around and buy physical copper and add to inventories at a time when inventories should fall (thereby causing spot prices to be too high) means buying high and selling low. Indeed, the market is likely in backwardation under those circumstances, and in that case prices tend to trend down–and everybody can see this. Not a good investment strategy! One almost guaranteed to lose money. Yes, maybe there are lemmings, greater fools, etc., but such people would be perfect short bait. (Though maybe Roaring Kitty will make copper ETFs a meme investment!)

The Hunts (mentioned in the article) are example of how irrational stock building and holding ends in tears. As I joke in class, the Hunts are the poster children for the old joke: “Want to make a small fortune in commodities? Start with a large fortune.” All because they propped up the price of silver by accumulating ever-expanding quantities of physical silver.

Another example that may be even more on point is the International Tin Council, which tried to imitate OPEC in the worst way–and succeeded. Rather than restrict output (a la OPEC) it tried to inflate prices by offering to purchase tin at supercompetitive prices. It ended up accumulating vast amounts of tin in storage, and when the money to keep buying tin ran out the price collapsed and the ITC suffered huge losses–and almost brought the LME down with it. (This is the so-called “Tin Crisis,” not to be mistaken with the LME’s “Nickel Crisis” of 2022).

In my 2012 post on physical metal ETFs, I wrote that one mechanism that would also limit the potential distortionary effects was that if such an ETF were uneconomically maintaining excessive physical stocks, someone could buy shares of the ETF, and tender them in exchange for physical metal, and then liquidate the stocks so obtained. That is, the ETF’s management could not unilaterally withhold stocks from the market.

If you look at the Sprott prospectus, you might conclude that use of that mechanism is highly restricted: there is an option to exchange shares for metal, but it can be exercised only on a semi-annual basis.

However! Elsewhere the prospectus says:

The Trust will have the ability to optimize the value of the Trust through Copper optimization transactions, including the use of futures, warrants, CME or LME warehouse receipts, and other financial
instruments [swaps? options?] to complement the Trust’s Copper procurement strategy, so long asthese transactions provide value to the Trust.

So this isn’t a pure copper piggy bank for shiny pennies or the cathodes you can make them from. If the fund is managed to maximize value, it will trade its physical copper optimally, and reduce stocks when the price signals indicate this is optimal. For example, it could sell inventories outright and replace the copper exposure with futures with deferred expiration dates. Or it could engage in spread transactions that are common on LME, e.g., selling cash and buying three month or 15 month or whatever futures.

In this respect, the ETF is really more analogous to a hedge fund. It’s managers have a lot of trading discretion within the copper space. In this respect it is very different than other commodity ETFs (e.g., the US Oil Fund) which have virtually no discretion.

Indeed, it is my sneaking suspicion that the fund’s restriction on withdrawals of metal is due precisely to the fact that it will essentially be engaged in fractional reserve banking, as it were. That is, its potential obligations to deliver will exceed its holdings of physical metal because its “optimization transactions” will involve accumulation of large paper positions, and its notional tonnage will exceed substantially its actual physical holdings. This restriction is analogous to the restrictions on withdrawals that hedge funds impose on investors–another point of tangency between this ETF and hedge funds.

Furthermore, even if the money is dumb and the managers are too (or are like Scrooge McDuck and just enjoy frolicking in their shiny stash), it can only distort supply to the extent its physical holdings are somehow pivotal, and/or there isn’t a lot of competition among those holding copper stocks. If total stocks should fall by X, as long as enough others collectively hold more than X they can supply that copper to the market even if the Sprott fund ignores the price signal and keeps a death grip on its physical holdings.

As for “cornering,” here Javier is playing fast and loose with a loaded term. The word (and squeeze, also used in the article) connotes manipulation. Manipulation is intentional conduct. Under US law in particular, it is conduct that involves a specific intent to cause “artificial prices.” (The Frankendodd revisions of the Commodity Exchange Act and CFTC regulations issued pursuant thereto have new provisions that arguably weaken the intent requirement, but it remains in Section 9).

Yes, an ETF that can take physical ownership can corner whereas a purely futures ETF that cannot own physical cannot. (I’d also note that a fund that holds ONLY physical metal cannot engage in market power manipulation either, or at least is guaranteed to lose money if it tries). But using the “optimization transactions” in futures to manipulate a market crosses a legal line, and indeed, a line that has been in place for over a century. That is something regulators (and market participants who have private right of action under the CEA) would be very unrelaxed about.

Moreover the incremental manipulation potential posed by this ETF is likely small. Manipulations have occurred in copper, and the industrial metals, from time immemorial. Remember Sumitomo? There have been other though less severe and shorter lasting cases of likely manipulation on the LME in the decades since. The proximate cause of the Panic of 1907 was a copper squeeze. Right now with all of the hedge fund money out there, as well as the big physical players, the potential for market power manipulation is omnipresent. Sprott will be a minnow in this ocean that already has a lot of big sharks.

I also chuckle at this concern about cornering. I excoriated Javier Blas severely for his failure to see that yes, a hedge fund–Armajaro–cornered the cocoa market in 2010. Indeed Javier seemed to have a man crush on the eventually disgraced head of the fund, Anthony Ward (AKA “Chocfinger”). One of my posts suggested they get a room. (Ward’s karma came a few years later when he bet wrong in the cocoa market, and Armajaro–which had taken delivery of enough beans to make billions of Hershey Bars in 2010–was sold for less than the price of one of these).

So I reprise my 2012 Alfred E. Neuman persona: What, me worry? Well, certainly not about a physical copper ETF.