The Dual Nature of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, perpetual futures, or 'perps,' are often the first topic that arises. These derivatives contracts allow traders to control large positions with minimal capital. Unlike standard futures, perps do not have an expiration date, making them a unique and popular choice among traders. For many altcoins, perps are the primary derivatives option available, as dated futures for these tokens are often illiquid and spot markets are less relevant for short-term traders. CoinDesk spoke with traders who have found success in the perpetual futures market to understand the appeal of perps, how they cater to both institutional and retail traders, and the associated costs. The traders' responses highlighted the deep liquidity, low trading fees, and efficient margin usage of perps as key benefits. However, they also noted that funding rates, which are recurring costs for maintaining open positions, pose a significant concern. Funding rates can be thought of as interest charges that accrue over time, and traders worry about their potential impact on profitability. The appeal of perps can be attributed to their necessity in the crypto market. According to Lucas Krenn, a derivatives trader at STS Digital, perps are the foundation of his firm's operations, particularly for tokens other than Bitcoin and Ether, where dated futures liquidity is scarce. Krenn explained that the process of replacing dated futures contracts at expiry is costly, which is why perps have become a preferred choice. Kenneth Ong, an independent trader, shared a similar perspective, emphasizing the benefits of perps for retail traders, including better execution prices, lower fees, and the ability to hedge positions. Ong noted that perps offer a significant advantage over traditional futures, as they allow traders to hold both long and short positions on the same token simultaneously. Both Krenn and Ong stressed that margin efficiency is a major draw for perps, enabling traders to manage risk effectively across different venues and tokens. The perpetual nature of perps has also shifted the dynamics of price discovery, allowing it to occur at any time, rather than being limited to traditional market hours. This has been particularly evident in the tokenized oil market, where traders have taken advantage of perps to react to news and events outside of regular trading hours. Despite the benefits of perps, traders are wary of the funding rate, which can be volatile and difficult to predict. Krenn and Ong warned that funding rates can become a significant burden for traders, especially those who hold positions for extended periods. The funding rate is typically charged every eight hours and can be a challenge to quantify and hedge. Krenn described it as 'unquantifiable at the point of trade and unhedgeable afterwards.' The traders also addressed the criticism that perps faced during the October 2022 market downturn, when exchanges socialized losses to protect their systems, resulting in the forced closure of both profitable and unprofitable positions. Krenn argued that this issue was not inherent to perps, but rather a problem with the crypto exchange margin model. He emphasized that the key distinction lies in whether a trader is facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn offered an interesting insight into the asymmetry of perp risk, suggesting that being long is structurally safer due to the ease of arbitraging away positive funding. However, when the funding rate is negative, the arbitrage becomes more complex, and the gap between perp and spot prices can persist. This asymmetry is often overlooked in risk models, according to Krenn. In conclusion, perps have democratized futures trading by addressing issues of access, cost, and margin efficiency. Nevertheless, they come with unique challenges, such as volatile funding-rate exposure, which cannot be quantified or hedged. As Krenn noted, the crypto market is currently carrying an interest rate exposure that it cannot price or hedge, making funding a 'tax' that everyone pays for access to this leveraged market.