The Double-Edged Sword of Perpetual Futures in Crypto Trading

Discussing crypto trading with experienced traders often leads to a conversation about perpetual futures, or 'perps' – a type of derivative contract that allows traders to control large positions with minimal capital. Perps function similarly to standard futures but without an expiration date. For traders of alternative cryptocurrencies, perps may be the only viable option for derivatives trading, as dated futures contracts for these assets are often illiquid. Spot markets, on the other hand, are typically used for long-term holdings. CoinDesk spoke with traders who have found success in the perpetual futures market to understand what sets perps apart, how they cater to the needs of both institutional and retail traders, and the associated costs of trading perps. The traders' responses highlighted the deep liquidity, low trading fees, and efficient margin usage of perps as key advantages. However, they also expressed concerns about funding rates – recurring costs for maintaining open positions. Funding rates can be thought of as interest charges that accumulate over time. Traders are worried about the potential for these charges to add up significantly. So, why do perps dominate the crypto landscape, with daily trading volumes exceeding $200 billion? According to Lucas Krenn, a derivatives trader at STS Digital, perps are not just one tool among many – they are the primary instrument for crypto-native firms. Krenn attributes the popularity of perps to the lack of liquidity in dated futures contracts, particularly for assets other than bitcoin and ether. The process of replacing expired contracts is costly, making perps a more efficient choice. Kenneth Ong, an independent trader, shares a similar perspective, citing the benefits of perps for retail traders, including better trade execution, lower fees, and the ability to hold both long and short positions simultaneously. Ong notes that perps offer a significant advantage over traditional futures contracts, which typically require a single account to be netted by default. Both Krenn and Ong emphasize the importance of margin efficiency in perps, which allows traders to manage risk effectively across different venues and assets. The perpetual nature of perps has also shifted the dynamics of price discovery, enabling traders to react to news and events in real-time, rather than waiting for traditional markets to open. This has been particularly evident in the tokenized oil market, where perps have allowed traders to respond quickly to geopolitical events. However, the funding rate remains a concern for traders. Unlike dated futures contracts, which have a fixed interest rate, perps have a funding rate that changes over time and is typically charged every eight hours. This exposes traders to a floating rate, making it challenging to quantify and hedge against potential losses. Krenn and Ong warn that the funding rate can become a significant burden, especially for traders who hold positions for extended periods. The issue of funding rates is further complicated by the lack of a built-in mechanism to lock in rates, leaving traders vulnerable to market fluctuations. In addition to funding rates, the crypto market has also experienced issues with liquidations, which can result in forced closures of positions due to margin shortages. While perps have democratized access to futures trading, they are not without unique challenges, including the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn puts 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.' For now, funding rates remain the 'tax' that everyone pays for access to this leveraged market.