Why the Question Over How to Regulate Perps Has Turned Into a Fight

Transcript

But I do kind of go back to first principles and think about Wolf DoddFrank which created swaps and even futures recreated for so totally different products and so I do continue to worry about trying to strap on regulation that wasn't fit for purpose and sort of missing out on the risks here. Uh the SEC recently put out what's called red crypto and it and it talks about disclosures for crypto offerings that are submit to investment contracts. And what it does is it very well is it ask questions that are sort of tailored to an actual crypto offering. I think we need something similar when it's talking about per making sure that we're not solely focusing on are they on an exchange but thinking about what they actually do and how they're very good at

they're very fundamentally different from swaps and they don't have the opacity and those types of issues we had during DoddFrank but there could be other risks that we need to be on the lookout for and regulation need to try to capture. Hi all. Today we are replaying a panel I moderated on Wednesday at the RWA Summit in Brooklyn titled Are PERPS poking the regulator bare or showing the art of the possible? It featured Jake Shervinsky of the Hyperlquid Policy Center, Tiffany Smith of Wilmer Hail, and Kathy Yun of Temporal. Originally, CME, the elephant in the room, which is perceived to be trying to do things that are anti-competitive to per was also supposed to be represented on the panel,

but they backed out last minute. The panel had some spicy things to say about that. Our discussion was extremely timely as the day before news broke that Hyperlid was in talks with Kraken parent company Payword to bring Hyperlid on shore. So without further ado, please enjoy this discussion. This episode is brought to you by 1-in Aqua, the shared liquidity layer from 1 in. Back multiple liquidity positions with one wallet balance and keep your tokens in your wallet until a swap fills. See how it works at 1in.com/aqua.

Hi everyone, thanks so much for coming to our panel. Are pers poking the regulator bear or showing the art of the possible? I'm here with Kathy Yun of Temporal, Tiffany Smith of Wilmer Hail, and Jake Shervinsky of the Hyperlquid Policy Center. And we have a really spicy discussion on tap for you all because some of you may know that um this is an area that's um under a lot of contention at the moment. Um the CME is actually suing its regulator and the CFTC about um pers that were approved for Cali. And what's um at you know kind of the center of this all is how these should be defined. Um CI contends that

these threaten their longdated futures. They think that actually per should be defined as swaps. It's a whole um I know this sort of gets in the weeds, but I think there is something important at the heart of this. So um Jake, why don't we start with you? Do you want to describe like what the conflict is about and you know why you think that definition is important? So the the key question really comes down to who will get access to this type of financial instrument in the US and the classification of a perpetual contract as either a swap or a future dictates whether it is only an institutional product as swaps are generally speaking to oversimplify a little bit primarily an institutional product that cannot trade on a registered designated

contract market whereas futures are a product that can be traded by a DCM um for a retail audience. And so we can talk more about the benefits of perpetuals, but my view and the view of the hyperlquid policy center is that they are an extraordinarily useful tool and a a better derivative in many cases for many users than David futures or options and should be available to the broadest number of people end users and uh hedgers and speculators in the US and for that reason they should be classified as futures. Furthermore, if you sort of run the legal analysis on whether they should be classified one way or another, they they do really um uh fall more into the bucket of futures.

But this is the the key issue here is who will have access to this innovative financial product here in the US. >> And Tiffany, can you give um more insight into, you know, what those definitions mean and why it is that or or which one you think it probably falls into more. >> So, I'm I'm not going to get into controversy. Um, but I I'll give a a couple of a couple of thoughts. So, first I think when you think about perpetual futures and just how they are, if you think about the definitions of swaps and futures, they have it's really have characteristics of both, but I think the future is a better category for them. One, because they're they're standardized. They're not um they're not bilateral contracts like most swaps are,

and I think two, like the pricing mechanism is more similar to futures. But we're at this situation in part because of the regulation by enforcement environment we had years ago. And so what happened was there were five different CFTC enforcement actions where you had in the enforcement context the CFTC took the position that pers were swaps. And because of that some people in the industry sort of started to believe that view. And so for the first time when you actually have not the enforcement arm but a policy setting division of the CFTC establishing how to view per they actually call it a future.

And so to the extent there is any type of um confusion in the market, that's part of it. And so that's again another example of what happens where you have regulation by enforcement. You don't actually have the policies divisions establishing how to categorize these different products. >> Kathy, what about you? What's your opinion? >> I mean, I'm obviously in the futures camp. Um, but I I think the difference and that I think that's something that CNE seems to be missing the point on or refuses to even see is we're we're talking about something very different than what they're used to. And when you are talking about something more smart contract based for me, I look at that as more being more venue focused than um

something that is more bilateral that you would see in swaps. And I think we are at a great time where we have this technology where we have smart contract technology uh where you're able to deal with uh autonomous code and you it's it's much more accessible to so many different people at this point and you don't have to be a sophisticated um participant um governed by some agency's rules at this point. And so hopefully it's more of leaning more towards democratization of having access to these financial products and then maybe just looking at how those products are being accessible

to the public as opposed to trying to figure out what has historically been done in the past. Um are there intermediaries? Who is taking the the liability for for these types of products? I I think with the advent of where things are going, especially from a a spot trading perspective for crypto, um there are a number of prop amounts that are blowing up right now. You have um they're trading for their own account. Yeah. You don't have counterparties. You don't have other users. You're not um risking other users money at this point. Uh you're just risking your own. And so I think it's a different emphasis and just something

different that we all should be thinking about. >> Yeah. So let's talk about that because this is sort of like you know this moment where we have this entity that is very dominant in the space CME and there's this new technology that does things a completely different way. And I saw Tiffany nodding her head when Kathy was talking about just the differences between onchain trading. You know, what does it mean when you're trading um with a smart contract versus or on a smart contract versus with intermediaries? And you know, we've had these existing regulations that have applied in a completely different environment. So, I'm so curious to hear how you think regulations should accommodate this new

technology that really just does things in a completely different way from how the regulations have from from the from the setup that the regulations have applied to thus far and either one of you. So yeah, I it's a it's a great question and you know unfortunately if if you all had uh seen the plan for this panel before this week, we we were going to be accompanied by someone from the CME and I was very excited to hear uh their answer to this question. So we'll have to to do the best uh that we can having this conversation without them. But I think in the first instance it is important to separate the perpetual future, a financial instrument, a new type of derivative as Kathy was saying from the venue where it trades. And at this moment, the CFTC has authorized the

trading of perpetual futures and has classified them as futures for centralized exchanges. And the CFTC did that a couple of months ago in two orders directed toward Coinbase and Kalshi, allowing them to trade for the first time a true perpetual contract with Bitcoin as the underlying asset. And that has frankly nothing to do with whether that perpetual will be traded on chain or using any new type of technology. And the CME unfortunately disagreed even with that authorization, an authorization that would have allowed it, the CME itself to offer that exact same product and filed a lawsuit against the CFTC saying both that the process that they used to come to that

determination was uh flawed and also that the determination itself was substantively incorrect that perpetuals are swaps rather than futures. And so I think we first have to overcome this initial question. What is the classification of the derivative itself? And then separate from that we have to ask the question once we have that classification where will those contracts and every other type of derivative dated futures and options and others where will they be allowed to trade and so it's sort of a multi-step process of figuring out can we have per in the US and then what kind of technology can we use in order to to have them trading live with a retail or institutional audience.

>> Yeah. I mean I'll add so the second part like the second question there the kamaya's exchange act um which is distinct from the securities regulations sort of uh assumes that for swaps and futures are traded on exchanges and so um we think about project crypto which chair Atkins of the SEC announced and later on chairle sort of uh agreed to sort of sign on to that and thinking about markets moving onchain that sort of understands that with onchain markets, you don't necessarily need an intermediary. And so we were thinking about how these markets can actually work. We have to look at what the regulations say and see whether or not they need to be sometimes exempt or sometimes um revised to reflect the

reality of these markets. Because what has happened, we're starting to see this with some of the regulations from the SEC. If you take a regulation that's not fit for purpose, you sort of put it on a new novel pro uh product, it results in there not being a good fit from a compliance perspective. It's both overincclusive and that requires um certain compliance requirements that don't make sense and underinclusive because it's not asking the right riskbased smart contract based types of questions. And so I agree with Jake that's going to be a two-step multi-prong uh analysis and two questions to look at, but I think we are actually moving towards onchain markets, but we're just in the very very beginning stages of getting to that

reality. >> Yeah, I mean I really wish the CME were here. Um but we can have fun without them. Um, I I I do think it's um my hot take is it's a little bit cowardice that they couldn't show up and and and jam with us on this topic. Um, I don't think we were particularly spicy on our prep call, but I I do think there is, you know, a fundamental difference with the way techn this technology is making new products um appear, how people are thinking about how we interact uh with new products and how we interact with other users or investors in this space.

And I think it's a little shortsighted of the CME to even try to hold on to their current position based on things that have been going on with less than stellar technology to begin with. Um, and so we should be looking forward. So another reason that pers have been such a hot topic this year is because you know so obviously crypto pers have been popular in crypto for a long time but we saw that real world asset perks really started to take off even on hyperlquid um you know the volumes of real world assets would exceed you know for instance like bitcoin perks and stuff. So, um, this is clearly I mean I

I think this is why we're discussing it here at the Real World Asset Summit, but you know, I'm curious to hear your thoughts on whether or not crypto pers are like a fundamentally different product from these real world asset per if you think they can be covered by the same rules. >> Well, I guess I'll start. I don't think there's anything unique about the underlying asset of any derivative that should change how the derivative is regulated. And I I think it is absolutely true that one reason we're talking about perpetuals now is because they have proven to be an extremely useful tool for hedgers and speculators outside of the crypto markets. Granted, perpetuals were in some ways an innovation of crypto because they became popular because of crypto exchanges

offering them for the first time. But perpetuals are in so many ways just a better derivative for for many use cases. They don't have fragmented liquidity across many expiration dates. So they have much deeper liquidity. They're a much simpler instrument to use because they very closely track the price of the underlying asset unlike a dated future that has to converge over time or an auction which is is quite difficult to price. And these benefits have have shown themselves to be useful in markets for metals like silver and gold, in markets for oil, as you mentioned, and potentially many other markets where continuous exposure or 24/7 trading nights and weekends is beneficial in a way that traditional

venues don't offer at this point. And the question isn't whether the underlying asset is a digital asset or not. The question really is from a regulatory perspective, is the underlying asset a commodity or is it a security? And that begs the question whether the CFTC or the SEC will regulate it. But otherwise, there really isn't any difference in terms of the legal treatment. There is however a very important policy element to this which is that physical commodities which have deliverable markets that affect global trade in a very important way have the potential to be much more affected by the rise of a brand new type of financial instrument than digital assets. And so this is why the CFTC in

moving forward with authorizing the trading of perpetuals decided to start with perpetuals on digital assets and then evaluate other asset classes one by one to figure out if they allow the trading of for example oil perpetuals, what impact will that have on the energy industry? or if they were to allow the trading of perpetuals on agricultural commodities, what effect might that have on the food supply and you know other extraordinarily important sectors within the agriculture industry and from a policy perspective totally appropriate for the CFTC to take these assets one at a time and not move fast and break things where the global derivatives markets are so critical to how we live our lives.

>> Yeah, I mean I'll just add so I agree with what with what Jake said. I think when you're thinking about categorizing these assets like we're using existing categories, right? So futures. So first off, the SEC and CFTC have sort of like two counterparts to both the futures regime and the swap regime, right? A future security future, a swap security based swap. And so and the futures regime comes back from 2000 commodities uh modernization act and then swaps come from 2010, right? So again, you have these old categories that you're uh using for these newer assets. And so maybe we can, as we're debating now, you can go back and forth

about how to categorize an assets being a swap or a future. But the point is that even if you try to fit into that category, some tweets are going to need to be made because they were that those categories were created in different contexts. Another thing to sort of keep in mind is that, you know, as Jake alluded to, like yes, like the the perp started in the crypto markets, but as we're looking at RWAs and assets with underlying our securities, it's important to make sure that we're not taking, you know, two different types of views on the SEC and CFTC side. And so some past enforcement actions, you had the CFTC take a view that one asset, it was a both agencies brought enforcement actions. CFTC said an asset was a swath.

SEC said it was a future, right? And so with these harmonization efforts between the agencies, hopefully you don't go back to those days. But it's just important that people think about the entire picture and realize that you have two different sets of assets that may go back and forth between two different regulatory regimes. >> $540 million. That's how much concentrated liquidity sat idle in a given week in the first half of this year. About 30% of the DeFi TVL if you're wondering. That's according to Dune Research commissioned by 1 in. But there's a solution. 1-in Aqua is the new shared liquidity platform. It lets LPS back multiple positions with the same token balance and keep their tokens in their wallet till a swap comes. Why does

that help? Because the LPS don't have to split their tokens across positions. They can cover more market conditions and pairs with their full balance. That means more activity across deeper liquidity. See how it works at 1in.com/aqua. Remember that providing liquidity carries risk and fees aren't guaranteed. >> Well, actually um so one thing which I if excuse me if I missed this, but do you have an opinion on whether or not these should be regulated more by CFTC or SUC or >> it's both. It's it's going to be both depending on what the underlying is. I think that the harmonization efforts between the agencies will help hopefully make compliance and a regulation run smoother. Right? So there's examples

today where if you're a narrowbased index, you're under the SEC's regime and if you're a broad-based indicy, you're under the the CFTC regime. And one particular asset can sort of uh migrate between these two different regimes. So hopefully with the harmonization as we get more novel products that can move that move 247 you can get some better uh coordination between the agencies so that you have like one primary regulator and another one sort of like or secondary regulator and they're sharing information but I think there's going to be a place for for both agencies especially with these different types of products that are being developed. I I totally agree and and I I think there's a careful line drawing exercise that the agencies are engaged in to figure out who regulates what and some of that is

actually playing out in the event contract space much more so than in the in the perpetual space. Questions like if you have an event contract based on what price a stock will be at a given time, should the SEC regulate that as a securitybased derivative? But then you might have an event contract that resolves based on what a company's reported earnings are. Or you might have something that uh resolves based on what the output of the company is. And it's hard to draw the line at what point that event contract is based on a a security or not. And I think we'll see the same type of thing play out in the perpetual space. But again, not an issue that's unique to perpetuals. It applies for all derivatives. and also not an issue

that's unique to onchain markets versus traditional markets. >> Okay. Well, so now I want to ask about some news that broke yesterday. Um Bloomberg reported that Hyperlid is talking with Payword, which is the parent company of Kraken, about coming on shore through Bitnomial, which Kraken acquired. And um I mean, so Jake, I don't know what you can say. Um but I'm so curious about what this would look like. I'm assuming obviously there's probably KYC involved, but I just imagine it also fragments liquidity. So, I'm kind of wondering how that all looks. I'm even wondering, you know, how does HIPP3 kind of, you know, concepts uh kind of play in here and and how how

is that regulated? Um, so I don't know how much you can say, but if you want to sort of describe, you know, what that might look like, you don't have to reveal anything. >> Well, I'll start by by saying two things. One is we're the hyperlquid policy center. So we're independent of the entities that were uh cited in the report and also I I have the information you have because you know I get this on the same way that you do. Um but what I can say from the perspective of what it means to onshore hyperlquid and I think this also applies for any market that will trade settle and clear on any public blockchain. What we have to do is is listen carefully to what the regulators are telling us and also without having to get into any details of our own engagement with the

regulators. When you listen to Chairman Celig talk about his effort to bring onchain markets into the United States, you'll hear him say that decentralization doesn't really have a place in the federal commodities laws. There's not a concept of DeFi or decentralized finance that's baked into the Commodity Exchange Act. The way that the CFTC's framework operates is that the CFTC regulates registered exchanges, DCMS, and clearing houses, DCOs, which have customer funds sent to them through brokers, either futures commission merchants or introducing brokers. And that is very much the

regulatory framework that I would expect the CFTC to apply in this case. When it comes to something like Hyperlquid, a public blockchain where these types of financial instruments and and many others can trade, I I think it is a mistake to think of Hyperlquid as an exchange. Hyperlid is not an exchange. Hyperlid is infrastructure that any exchange can use in order to offer the best product or service to their customers. So in my view, if if any other exchange were in the room, my message to them would be you should be using Hyperlquid because it will enable you to offer a better product or service to your customer. And the work that needs to be done at the agencies, both the CFTC and the SEC, is to figure out

how can the underlying policy goals of the regulation in the CFTC context, the core principles that a registered exchange must comply with, how can those core principles be satisfied where the exchange is offering a product using neutral infrastructure that they themselves do not control and also no single third party controls. And that I think is is the uh the the sort of devil in the details issue that the agencies are working through now. >> Yeah. And I mean and the interesting thing is that you have so many projects right now who see public blockchains rightly so as communication layers and that you are building different products and different applications on top of

this. And so if you think of the hyperlquids and salamanders of the world as just pure communication lines, um it's inappropriate to think of them as exchanges. Um it's inappropriate to think that a smart contract is an exchange because there is no control. Um as long as it's done correctly, there should be no control. um and that you have this autonomous thing that people are able to interact with and um they're able to determine their own personal risk. Uh regulation has always existed in order to protect consumers or to um

protect participants from outsiz ridiculous losses. Um I I think that uh the thinking has to change a little bit when you're now dealing with engineers or projects who are now bu using this technology to create things in order to meet the need of lots of different people. Um, and how do we regulate something where you don't have someone standing in your middle? Um, and custodying or just being an intermediary in any way.

Tibli, do you want to add anything on >> I mean not not much. I think I both covered it well. I think sort of like I was alluding to earlier um when you have, you know, software not people, I think the risk can be different. And so that's why it's important to sort of understand the distinctions and making sure that whatever regulation we had is actually like uh you know purpose-built for whatever the application is whatever whatever we're talking about and not just sort of like taking what we've always had and just putting into putting on over top of brand new software and expecting it to work and capture all the risks.

>> Right. So for our final question, this is maybe a big question um but you know I want to go back to how we started which is we're in this moment where you know we have this incumbent we have this new technology um I think some people in the crypto industry perceive that the incumbent is trying to do things that are anti-competition and you know um the reason that I am interested in crypto is you know I do think it is a superior technology um I'm sure probably uh there's kind of pros and bonds, but at least on efficiency, we can probably say that. So, if you were in the regulator seat, I would be so interested to hear how you would design fair regulations for this moment.

Um, and I know, like I said, it's a big question. Uh, but even in broad strokes, if if each of you want to take a stab at that. >> All right. Well, I guess I'll I'll I'll answer in two parts. Um, I'll start by saying I I think that in a dream world, many of us who have worked in the crypto industry have viewed disintermediation as the goal of the new financial system that we've wanted to build. Viewing intermediaries as introducing risk into the financial system and viewing onchain markets as a way to address that risk through software rather than through regulation. And I I do think that there are some merits to that argument. That

said, as I mentioned, in the world that we live in, and I do think that it's important for us to approach this question from a pragmatic perspective, the the statute, the Commodity Exchange Act that the CFTC enforces doesn't really consider that concept of disintermediation. So what we would need if we wanted to get to that world where there are no exchanges because everyone is just trading directly on chain without having a broker and without having to rely on a clearing house etc. probably we would need Congress to step in and decide to amend the Commodity Exchange Act. And I hate to break it to anyone who thinks that that's on the table. That's not happening anytime soon. There are also plenty of I think very interesting legal theories as to why the CFTC has

exemptive authority that would allow it to look at the tax stack and decide that there are no intermediaries or should not have to be any intermediaries. But even that I think is a very difficult argument to make because the commodity exchange act at its core mandates that futures trade on an exchange. So even if you say there are no intermediaries here, all you've done is establish that there's no intermediary through which an American can lawfully access the product. So if we're going to be pragmatic about this, we have to take the law as it is. And again, we have to listen to the regulators. What the regulators will say over and over is that they are taking a crawl walk run approach to bringing onchain markets

into the US and moving the financial system onto public blockchains. And what that means is it may not be satisfactory to many who have more radical ideas about how we should reshape global finance, but it is much more likely that we will start by having these products perpetual futures offered through the regulatory framework that the agency administers and we will see those intermediaries authorized to use better technology in order to improve the product and service that they offer. And that's the uh that's the uh path that I think we'll be taking in the foreseeable future.

Yeah, I mean I agree that is the the path that we're going to see in a foreseeable future, but I do kind of go back to first principles and think about both dod frame which created swaps and even futures recreated for so totally different products and so I do continue to worry about trying to strap on regulation that wasn't fit for purpose and sort of missing out on the risks here right and so sort of like The SEC recently put out, let's call it red crypto, and it and it talks about disclosures for crypto offerings that are submit to investment contracts. And what it does is it very well is it ask questions that are sort of tailored to an actual crypto offering. We do

something similar when it's talking about per making sure that we're not solely focusing on are they on an exchange, but thinking about what they actually do and how they're very good at, you know, they're they're very fundamentally different from swaps and they don't have the opacity and those types of issues we had during DoddFrank, but there could be other risks that we need to be on the lookout for and regulation needs to try to capture. >> I hate your outlined realistic view of how things are going. I I mean it's my um experience of going to the Hill and speaking with staffers and and members of Congress and different agencies is that no one comprehends that there is a whole world onchain. They only think

about things from an on-ramp and off-ramp perspective and they have no idea that you can access onchain the onchain world onchain activity without going through those on-ramps or other intermediaries. Um, I'm not saying that there should be no regulation. There might need to be something, but I think the concerns that regulators have had historically for these more traditional products don't necessarily exist for a lot of the new innovative products that are that are coming to the market. Um, it would be a shame for people in the US to be able to miss out on something. It would be a shame for US traders um who are enga who will always be engaged in speculative um activities to prevent

them from having access to this. >> Yeah. Yeah. I'm sure a lot of people in here would agree with that. Um well, thank you to our panelists for having a great discussion. I uh really enjoyed and hopefully um the rest of you did as well. Nothing you hear on Unchained is investment advice. This show is forformational and entertainment purposes only, and my guest and I may hold assets discussed on the show. For more disclosures, visit unchainedcrypto.com.