The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' often comes up. These derivatives contracts enable traders to control large positions with minimal capital. Unlike standard futures, perps do not have an expiration date. For traders of alternative cryptocurrencies, perps may be the only viable option for derivatives trading, as dated futures for these assets are often illiquid. The spot market is also not a viable option for short-term traders. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart from other derivatives and how they cater to the needs of both institutional and retail traders. The traders unanimously agreed that perps offer deep liquidity, low trading fees, and efficient margin usage. However, they also expressed concerns over funding rates, which are recurring costs associated with keeping positions open. Funding rates can be thought of as interest charges that accrue over time. Lucas Krenn, a derivatives trader at STS Digital, stated that perps are the primary tool for crypto native firms, as dated futures lack liquidity outside of bitcoin and ether. Kenneth Ong, an independent trader, highlighted the benefits of perps for retail traders, including better order execution, lower fees, and the ability to hold both long and short positions simultaneously. Both Krenn and Ong emphasized that margin efficiency is a significant advantage of perps, allowing traders to manage risk across multiple venues and tokens with minimal capital. The perpetual nature of perps has also shifted price discovery to a 24/7 process, rather than being limited to traditional market hours. Ong cited the example of tokenized oil trading during the Iran conflict, where perps allowed for rapid price adjustments outside of traditional market hours. Krenn noted that perps have become a powerful tool for trading various assets, including tokenized equities, as they sidestep the need for recreating traditional share ownership infrastructure. However, both traders warned about the risks associated with funding rates, which can be unpredictable and potentially costly. Krenn stated that funding rates are 'unquantifiable at the point of trade and unhedgeable afterwards,' making them a significant concern for traders. Ong added that funding rates can 'potentially balloon to the point where a profitable trade loses money.' The traders also discussed the myth of the 'safe trade,' highlighting the risks of liquidations and the importance of understanding the underlying mechanics of perps. Krenn argued that the problems associated with perps are not inherent to the instrument itself, but rather a result of the crypto exchange margin model. He emphasized that the key distinction is not between perpetual and dated futures, but rather between exchanges with proper clearing houses and those that socialize losses onto winners. Krenn also offered an insight into the asymmetry of perp risk, noting that being long is often the structurally safer side due to the ease of arbitraging away positive funding rates. However, when funding rates are negative, the arbitrage process is more complex, and the gap between perp and spot prices can persist. In conclusion, perps have democratized futures trading by providing access, cost efficiency, and margin efficiency, but they also come with unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged.