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

When discussing crypto trading with experienced traders, perpetual futures, or 'perps,' are often the first topic that comes up. These derivatives contracts allow traders to control larger positions with less capital, and unlike standard futures, they have no 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 used for long-term holdings. CoinDesk spoke with traders who have thrived 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 praised perps for their deep liquidity, low trading fees, and efficient margin usage. However, they also expressed concerns over funding rates, which are recurring costs associated with keeping positions open. Funding rates can be thought of as interest charges that accrue over time, and traders worry about their impact on profitability. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at market-making firm STS Digital, perps are the 'plumbing underneath everything' his firm does. Outside of bitcoin and ether, dated futures contracts are often too illiquid to be useful, making perps the primary tool for crypto-native firms. Kenneth Ong, an independent trader, echoed this sentiment, highlighting perps' advantages for retail traders, including better fills, lower fees, and the ability to hold both long and short positions simultaneously. Both Krenn and Ong emphasized the importance of margin efficiency in perps, which enables traders to manage risk across multiple venues and tokens with greater ease. The perpetual nature of perps has also shifted price discovery to a 24/7 process, allowing traders to react to news and events in real-time. However, this always-on nature also means that funding rates can become a significant burden for traders, especially if they hold positions for extended periods. The funding rate, which is typically charged every eight hours, can be difficult to quantify and hedge, making it a major concern for traders. In fact, Krenn and Ong believe that funding rates are a more significant issue than liquidations, which are often cited as a major risk in perps. The traders also debunked the myth that perps are inherently riskier than dated futures, arguing that the problems associated with perps are often a result of exchange-specific issues, such as socialized losses and inadequate clearing houses. Krenn noted 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. In terms of risk, Krenn pointed out that being long is often the structurally safer side, as positive funding rates can be easily arbitraged away. However, when funding rates are negative, the arbitrage process can be more difficult, leading to persistent gaps between perp and spot prices. This asymmetry can result in unbounded costs for short positions, making them riskier than long positions. As the crypto market continues to evolve, perps are likely to remain a popular choice for traders, despite their unique challenges. Until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that is difficult to price and hedge. In the meantime, funding rates will remain a 'tax' that traders must pay for access to this leveraged market.