The Double-Edged Sword of Perpetual Futures: Benefits and Drawbacks

When discussing crypto trading with experienced traders, the conversation often revolves around perpetual futures, or 'perps' - a type of derivative contract that enables traders to control large positions with minimal capital. Unlike traditional futures contracts, perps do not have an expiration date, making them a popular choice among traders. For altcoin traders, perps are often the only viable option for derivatives trading, as dated futures contracts for these assets are typically illiquid. CoinDesk spoke with traders who have found success 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 several benefits, including deep liquidity, low trading fees, and efficient margin usage. However, they also expressed concerns over funding rates, which can add up over time and negatively impact trading profits. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the 'plumbing underneath everything' the firm does, as they provide a necessary tool for trading outside of bitcoin and ether. Kenneth Ong, an independent trader, also highlighted the advantages of perps, including better fills, lower fees, and the ability to run both long and short positions simultaneously. Both traders emphasized that margin efficiency is a major draw for perps, as they require only a fraction of a position's value as collateral, allowing traders to manage risk efficiently across multiple venues and tokens. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than just during market hours. This has led to increased trading activity in perps tied to traditional assets, such as tokenized oil. While perps offer many benefits, traders are also wary of the funding rate, which can be volatile and difficult to quantify. A dated futures contract, on the other hand, provides a clear interest rate from the outset. The funding rate for perps, which is typically charged every eight hours, can become a significant burden if the market does not move as expected. As Krenn noted, 'it is unquantifiable at the point of trade and unhedgeable afterwards.' Ong was more blunt, stating that 'if you hold positions for long periods, it can potentially balloon to the point where a profitable trade loses money.' The traders also discussed the risks associated with perps, including liquidations and the socialization of losses. However, Krenn argued that these issues are not unique to perps, but rather a result of the crypto exchange margin model. The distinction that matters, according to Krenn, is whether you are facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. In terms of risk, Krenn offered an interesting insight, suggesting that being long is the structurally safer side due to the ease of arbitraging away positive funding. However, when the funding rate is negative, the arbitrage becomes more difficult, and the gap between perp and spot prices can persist. This asymmetry is often overlooked in risk models, and it can lead to significant losses for short sellers. In conclusion, perps have democratized futures trading by providing access, cost efficiency, and margin efficiency, but they also come with unique challenges, particularly with regards to funding-rate exposure. 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.'