The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, perpetual futures, also known as 'perps,' are often the first topic that comes up. These derivatives contracts enable traders to control larger positions with less capital, offering an advantage over standard futures due to their lack of expiry dates. For traders of alternative cryptocurrencies, perps may be the only viable option for derivatives trading, as dated futures contracts for these coins are often illiquid. The spot market, on the other hand, is typically used for long-term holdings. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart from other derivatives, how they cater to the needs of both institutional and retail traders, and the costs associated with perps trading. The traders' responses highlighted the deep liquidity, low trading fees, and efficient margin usage of perps as key benefits. However, they also expressed concern over the funding rates, which can add up over time and impact trading profitability. One trader, Lucas Krenn, noted that perps are not just one tool among many, but rather the primary instrument for crypto-native firms due to the lack of liquidity in dated futures. Another trader, Kenneth Ong, explained that perps offer better execution, lower fees, and the ability to hold both long and short positions simultaneously. The perpetual nature of perps allows for price discovery to occur at any time, rather than only during market hours. This has led to a shift in how traders approach the market, with many opting for perps over traditional futures contracts. Despite the benefits, traders are wary of the funding rates, which can be volatile and difficult to hedge. Krenn noted that the funding rate is a recurring cost that can add up over time, making it a significant concern for traders. Ong also expressed concern, stating that the funding rate can potentially balloon and turn a profitable trade into a loss. The traders also discussed the risks associated with perps, including liquidations and the socialization of losses. However, Krenn argued that these risks are not unique to perps, but rather a result of the crypto exchange margin model. He noted that the key distinction is not between perpetual and dated futures, but rather between a proper clearing house with a mutualized default fund and an exchange that socializes losses onto winners. Krenn also offered an insight into the asymmetry of perp risk, noting that being long is structurally safer due to the ease of arbitraging away positive funding. However, when the funding rate is negative, the arbitrage is more difficult, and the gap between perp and spot prices can persist. This means that funding rates can stay extremely negative for long periods, making the long side have a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost. In conclusion, perps have democratized futures trading by solving the problems of access, cost, and margin efficiency. However, they are not without unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn put it, 'Until there is a liquid dated curve in crypto, the whole market is carrying an interest rate exposure it cannot price and cannot hedge.'