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

When discussing crypto trading, savvy traders often focus on perpetual futures, or 'perps,' which are derivatives contracts allowing traders to control larger positions with less capital. These contracts function similarly to standard futures but lack an expiry date. For traders of alternative cryptocurrencies, perps are often the only viable derivatives option due to the illiquidity of dated futures and the spot market. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart, how they cater to both institutional and retail traders, and the associated costs. The consensus among traders is that perps are favored for their deep liquidity, low trading fees, and efficient margin usage, which enables significant trading exposure with minimal collateral. However, traders also express concern about the funding rate, a recurring cost for maintaining open positions, akin to an interest charge that accrues over time. The reason for the popularity of perps, with daily volumes exceeding $200 billion, is attributed to necessity rather than choice. Lucas Krenn, a derivatives trader, notes that outside of bitcoin and ether, dated futures lack sufficient liquidity, making perps the primary tool for 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, highlights the advantages of perps for retail traders, including better fills, lower fees, and the ability to hold both long and short positions simultaneously through hedge mode. Both Krenn and Ong emphasize that margin efficiency is a significant draw to perps, as they require only a fraction of the position's value as collateral, enabling the management of risk across different venues and tokens. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than being limited to traditional market hours. This is particularly evident in the trading of tokenized commodities, where perps allow for more flexible and efficient price discovery. Despite the benefits, traders are cautious about the funding rate, which can become a significant burden if not managed properly. The funding rate, typically charged every eight hours, can expose traders to floating rates, making it challenging to quantify and hedge against. Krenn and Ong stress that the funding rate is a more pressing concern than liquidations, as it can potentially turn profitable trades into losses if not properly accounted for. The issue of funding rates is further complicated by the lack of a built-in mechanism to lock in rates and the difficulty in hedging against them. The traders also address the myth that perps are inherently risky, pointing out that the issues experienced during the October 10 crash were more related to the crypto exchange margin model than the perps themselves. Krenn notes that the distinction between perpetual and dated futures is less relevant than the difference between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Furthermore, Krenn offers an insight that challenges common assumptions about perp risk, suggesting that being long is structurally safer due to the ease of arbitraging away positive funding rates. However, when funding rates are negative, arbitrage becomes more complex, leading to an asymmetry that few risk models account for. This asymmetry can result in funding rates staying extremely negative for extended periods, making the long side have a bounded cost and unbounded upside, while the short side has a bounded upside and unbounded cost. In conclusion, while perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, they also introduce unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn puts it, until a liquid dated curve exists in crypto, the market will carry an interest rate exposure it cannot price or hedge, making funding a 'tax' for access to this leveraged market.