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 of conversation. 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 attractive option for traders. For altcoin traders, perps are often the only viable derivatives market, as dated futures for these coins are typically illiquid, and the spot market is less relevant for short-term trading strategies. 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 over funding rates, a recurring cost associated with keeping positions open. Funding rates can be thought of as an interest charge that accrues over time, and traders are worried about the potential impact on their profits. To understand the appeal of perps, it's essential to consider the limitations of dated futures. Lucas Krenn, a derivatives trader at STS Digital, noted that outside of bitcoin and ether, dated futures lack liquidity, making perps the primary tool for crypto-native firms. The process of replacing dated futures contracts at expiry is costly, which is why futures-based ETFs are often less efficient than spot ETFs. Perps, on the other hand, offer better liquidity, allowing for more stable prices and reduced slippage. Kenneth Ong, an independent trader, highlighted the benefits of perps from a retail trader's perspective, including better fills, lower fees, and the ability to hold both long and short positions simultaneously. This flexibility is a significant advantage over regulated venues like the CME, where accounts are typically netted by default. Ong and Krenn both emphasized that margin efficiency is a key draw to perps, as they require only a fraction of the position's value as collateral, allowing traders to manage risk across multiple venues and tokens. The perpetual nature of perps has also shifted price discovery, enabling traders to react to news and events outside of traditional market hours. During the Iran conflict, Ong witnessed firsthand how perps allowed for rapid price adjustments, even when traditional markets were closed. Krenn sees this mechanism playing out in perps tied to other assets, such as tokenized equities, which can sidestep the complexities of traditional share ownership. Both traders believe that the use of perps will continue to grow, with Ong noting that tokenized oil trading is a preview of what's to come for other commodities. As perps become more widespread, they will likely reduce the need for dated futures. However, traders must be aware of the funding rate, which can be a significant burden if not managed properly. A dated futures contract provides a clear interest rate, whereas perps have a funding rate that changes over time and is typically charged every eight hours. This exposes traders to a floating rate, which can be difficult to quantify and hedge. Krenn and Ong both expressed concerns over the funding rate, with Ong noting that it can potentially turn a profitable trade into a loss if held for an extended period. The recent bear market has also highlighted the risks associated with perps, particularly during times of high volatility. The October 10 crash triggered widespread deleveraging, resulting in the forced closure of both losing and profitable positions. While perps faced criticism, Krenn argued that the issue lies with the crypto exchange margin model, rather than the perpetual futures themselves. He emphasized that the key distinction is between facing a proper clearing house with a mutualized default fund and an exchange that socializes losses onto winners. Krenn also offered an insightful perspective on the asymmetry of perp risk, noting that being long is often the structurally safer side. This is because positive funding can be easily arbitraged away, whereas negative funding can persist due to constraints on shorting the underlying token. As a result, the long side has a bounded cost and unbounded upside, while the short side has a bounded upside and unbounded cost. This asymmetry is often overlooked in risk models, and Krenn pointed to the example of Euler's token, where funding on the perp went deeply negative, and shorts were forced to pay a high rate to longs. In conclusion, perps have democratized futures trading by addressing issues of access, cost, and margin efficiency. However, they are not without unique challenges, particularly the volatile funding-rate exposure that can be difficult to quantify and hedge. As Krenn noted, until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that it cannot price or hedge, making funding a tax that everyone pays for access to this leveraged market.