The Dual Nature of Perpetual Futures: Exploring the Pros and Cons

Discussing crypto trading with experienced traders often leads to conversations about perpetual futures, or 'perps,' which are derivative contracts allowing traders to control larger positions with less capital. Unlike standard futures, perps do not expire, making them a popular choice for traders. For altcoin traders, perps are often the only viable option for derivatives trading due to the illiquidity of dated futures and the spot market. 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 praised perps for their deep liquidity, low trading fees, and efficient margin usage, which enables traders to maximize their exposure with minimal collateral. However, they also expressed concerns about the funding rates associated with perps, which can add up over time and impact trading costs. The funding rate is essentially an interest charge that accrues the longer a position is held, and traders are worried about its potential to erode profits. Traders attribute the popularity of perps to their necessity, particularly for crypto-native firms, where they serve as a fundamental tool. Lucas Krenn, a derivatives trader at STS Digital, noted that outside of bitcoin and ether, dated futures lack liquidity, making perps the go-to option. Kenneth Ong, an independent trader, highlighted the advantages 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 the importance of margin efficiency in perps, which allows traders to manage risk across multiple venues and tokens with a single pool of capital. The perpetual nature of perps has also shifted price discovery to a 24/7 process, with traders reacting to news and events as they happen, rather than waiting for traditional market hours. This has led to increased trading activity in perps, even during weekends and holidays. Despite the benefits, traders are cautious about the funding rates, which can be volatile and difficult to predict. Krenn and Ong warned that funding rates can become a significant burden for traders, especially those holding positions for extended periods. The lack of a built-in mechanism to lock in funding rates exposes traders to floating rates, making it challenging to quantify and hedge against potential losses. The traders also addressed the misconception that perps are inherently riskier than dated futures, attributing past criticisms to issues with crypto exchange margin models rather than the perps themselves. Krenn pointed out that the key distinction lies in the presence of a proper clearing house with a mutualized default fund, rather than the type of futures contract used. Furthermore, Krenn highlighted an often-overlooked asymmetry in perp risk, where being long is structurally safer due to the ease of arbitraging away positive funding rates. In contrast, negative funding rates can persist for extended periods, making it difficult for traders to short the underlying token and compress the gap between perp and spot prices. This asymmetry can lead to unbounded costs for short positions and unbounded upside for long positions, which is not adequately accounted for in most risk models. As the crypto market continues to evolve, perps are likely to remain a popular choice for traders, despite their unique challenges. Until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that is difficult to price and hedge, making funding a necessary 'tax' for accessing this leveraged market.