The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' often comes up. These derivatives contracts allow 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 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 thrived in the perpetual futures market to understand what sets perps apart from other derivatives and how they efficiently meet the needs of both institutional and retail traders. The traders unanimously praised perps for their deep liquidity, low trading fees, and high margin efficiency. However, they also expressed concern over the funding rates, a recurring cost for maintaining open positions. Funding rates can be thought of as an interest charge that accumulates over time. Lucas Krenn, a derivatives trader, explained that perps are not just one tool among many but the primary tool for crypto-native firms due to the lack of liquidity in dated futures outside of bitcoin and ether. Kenneth Ong, an independent trader, highlighted the benefits of perps for retail traders, including better order execution, lower fees, and the ability to hold both long and short positions simultaneously. Both traders emphasized that margin efficiency is the key advantage of perps, allowing for greater trading exposure with less capital. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than just during market hours. This is particularly notable in times of high market volatility, such as during the Iran conflict, where significant price movements occurred outside traditional market hours. Despite the advantages, traders are wary of the funding rates, which can be unpredictable and may become a significant burden if not managed properly. The funding rate is typically charged every eight hours and can change over time, making it challenging for traders to quantify and hedge against. Krenn and Ong warned that holding positions for extended periods could lead to substantial losses due to funding rates, even if the trade is otherwise profitable. The issue of funding rates is further complicated by the lack of a built-in mechanism to lock in rates and the inability to hedge against them once a trade is open. The traders also addressed the criticism of perps following the October 10 crash, which led to widespread deleveraging and liquidations. Krenn argued that the problem was not with perps themselves but with the crypto exchange margin model. He emphasized that the distinction between perpetual and dated futures is less important than the presence of a proper clearing house with a mutualized default fund. Krenn also offered an insight into the asymmetry of perp risk, suggesting that being long is structurally safer due to the ease of arbitraging away positive funding. In contrast, negative funding rates can persist for extended periods, making the short side riskier. The example of Euler's token listing illustrated this point, where funding on the perp went deeply negative, and shorts were paying significant fees to longs. 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. As Krenn noted, until a liquid dated curve in crypto emerges, the market will continue to carry an interest rate exposure that cannot be accurately priced or hedged.