The Dual Nature of Perpetual Futures: Benefits and Drawbacks According to Crypto Traders

When discussing crypto trading with experienced traders, the conversation often centers around perpetual futures, or 'perps' – a type of derivative contract that enables traders to control larger positions with less capital. Unlike standard futures contracts, perps do not have an expiration date, making them a unique and attractive option for traders. For traders of alternative cryptocurrencies, perps are often the only viable derivatives market available, given the illiquidity of dated futures contracts and the spot market's limitations for short-term trading. Recently, CoinDesk spoke with traders who have found success in the perpetual futures market to understand what sets perps apart from other derivatives, how they cater to the needs of both institutional and individual 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 advantages. However, they also expressed concern over the funding rates, which are recurring costs for maintaining open positions and can significantly impact trading profitability. The popularity of perps can be attributed to their necessity in the crypto market, particularly for traders dealing with cryptocurrencies other than Bitcoin and Ethereum, where dated futures contracts are often too illiquid to be useful. According to Lucas Krenn, a derivatives trader at STS Digital, perps are not just one tool among many but are fundamental to the operations of crypto-native firms. The liquidity of perps allows for better execution of trades, with lower slippage and more favorable prices. Kenneth Ong, an independent trader, echoed this sentiment, noting that perps offer retail traders advantages such as better fills, lower fees, and the ability to hedge positions more effectively. One of the significant benefits of perps is their ability to provide efficient risk management across different venues and tokens, thanks to their high leverage. This allows traders to manage their risk more effectively, even with a fragmented market. The always-on nature of perps has also changed how price discovery occurs, allowing for more immediate reactions to news and events. This was evident during the Iran conflict, where tokenized oil trading saw significant activity on perps even when traditional markets were closed. Despite these advantages, traders are wary of the funding rate, which can be a significant expense for maintaining positions over time. Unlike dated futures contracts, which have a fixed interest rate, perps have a funding rate that changes and is typically charged every eight hours, leaving traders exposed to floating rates without a mechanism to lock them in. This can lead to unforeseen costs, especially if the market does not move as expected. The funding rate is considered more of a concern than liquidations, which are often cited as a risk of perps. The issue with funding rates is that they are unquantifiable at the point of trade and cannot be hedged afterward, making them a significant risk for traders. The concern over funding rates was highlighted during the October 10 crash, where exchanges socialized losses, leading to the liquidation of both losing and profitable positions. However, traders like Krenn argue that this was not a problem with perps themselves but rather with the crypto exchange margin model. The key distinction, according to Krenn, is not between perpetual and dated futures but between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn also pointed out an often-overlooked aspect of perp risk: the asymmetry between being long and being short. He argued that being long is structurally safer because positive funding can be easily arbitraged away, whereas negative funding is more difficult to arbitrage, leading to a situation where the gap between perp and spot prices can persist. This asymmetry means that the long side has a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost, an insight that few risk models account for. In conclusion, while perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, they also come with unique challenges, particularly the volatile funding rate exposure that cannot be quantified or hedged. As Krenn noted, until a liquid dated curve exists in crypto, the market will continue to carry an interest rate exposure that it cannot price or hedge, making funding a 'tax' everyone pays for access to this leveraged market.