The Double-Edged Sword of Perpetual Futures: Insights from Crypto Traders

When discussing crypto trading with experienced traders, the conversation often revolves around perpetual futures, or 'perps' – a type of derivatives contract that enables 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, as dated futures contracts for these assets tend to be illiquid. The spot market, on the other hand, is generally only considered by traders who plan to hold their positions long-term. CoinDesk spoke with traders who have thrived in the perpetual futures market to gain insight into what sets perps apart from other derivatives, how they cater to the needs of both institutional and retail traders, and the associated costs. The traders' responses were unanimous: perps are favored due to their deep liquidity, low trading fees, and efficient margin usage, which allows for significant trading exposure with minimal collateral. However, trading fees are not the only expense incurred by traders. There is also a recurring cost associated with maintaining open positions, known as funding rates, which can accumulate over time and are a concern for the traders interviewed. So, why do perps dominate the crypto derivatives market? Traders attribute the daily volume of over $200 billion in crypto perps to necessity rather than choice. Lucas Krenn, a derivatives trader at STS Digital, noted that perps are the primary tool for crypto-native firms, as dated futures contracts lack liquidity outside of bitcoin and ether. Krenn explained that the process of replacing dated futures contracts at expiration is costly, which is why futures-based ETFs are often less efficient than spot ETFs. Kenneth Ong, an independent trader, shared a similar perspective, highlighting the benefits of perps for retail traders, including better order execution, lower fees, and the ability to hold both long and short positions simultaneously. Ong emphasized that margin efficiency is the primary advantage of perps, allowing traders to manage risk across multiple venues and tokens with minimal 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 occur, rather than only during traditional market hours. Both Krenn and Ong see the 'perpification' of various assets gaining momentum in the coming years, with tokenized oil trading being a prime example. However, they also cautioned about the funding rate, which can be a significant burden for traders, particularly those holding positions for extended periods. The funding rate, which is typically charged every eight hours, can be unpredictable and may become a substantial expense if the market does not move as expected. Krenn and Ong warned that the funding rate can potentially turn a profitable trade into a loss. The traders also addressed the criticism that perps faced during the October 10 crash, which triggered widespread deleveraging across the crypto market. Krenn argued that the issue was not with perps themselves, but rather with the crypto exchange margin model, which socializes losses onto profitable trades. He emphasized that the key distinction is not between perpetual and dated futures, but rather between exchanges with proper clearing houses and mutualized default funds, and those that socialize losses onto winners. Krenn also 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 rates. However, when funding rates are negative, the arbitrage process is more complex, and the gap between perp and spot prices can persist, leading to extremely negative funding rates. In conclusion, while perps have democratized access to futures trading by addressing issues of access, cost, and margin efficiency, they also come with unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn noted, until a liquid dated curve emerges in the crypto market, the entire market will be exposed to an interest rate risk that cannot be priced or hedged, making funding a 'tax' that everyone pays for access to this leveraged market.