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 a larger position than the funds held in their account. Perps function similarly to standard futures but without an expiry 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, how they cater to the needs of both institutional and retail traders, and the costs associated with perps trading. The traders' responses were unanimous: everyone appreciates perps due to their deep liquidity, low trading fees, and efficient margin usage, which refers to the amount of trading exposure achievable per unit of collateral posted. However, trading fees are not the only expense traders incur. There is also a recurring cost for maintaining open positions, known as funding rates, which can be thought of as an interest charge that accumulates over time. Traders are concerned about the potential impact of these funding rates on their trading activities. So, why do perps dominate the crypto trading landscape? Traders attribute the average 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 foundation of his firm's operations, particularly for cryptocurrencies beyond Bitcoin and Ethereum, where dated futures contracts are virtually unusable due to their thin liquidity. Kenneth Ong, an independent trader, shared a similar perspective, highlighting the benefits of perps for retail traders, including better trade execution, lower fees, and the ability to hold both long and short positions simultaneously. Both traders emphasized that margin efficiency is a significant advantage of perps, allowing for the management of risk across different venues and tokens with greater ease. The perpetual nature of perps has also shifted the dynamics of price discovery, enabling it to occur at any time, rather than being limited to traditional market hours. This was evident during the Iran conflict, where tokenized oil trading on Hyperliquid experienced a surge in volume over a weekend, resulting in price adjustments before traditional markets reopened. Traders like Krenn and Ong see perps continuing to gain traction across various asset classes, potentially rendering dated futures less relevant. However, they also cautioned about the funding rate, which can be a significant burden for traders, especially when holding positions for extended periods. The funding rate, which is typically charged every eight hours, can lead to unforeseen expenses and is a concern for both institutional and retail traders. In conclusion, while perps have democratized access to futures trading by addressing issues of cost, accessibility, and margin efficiency, they also introduce unique challenges, notably the volatile and unpredictable funding rate exposure that cannot be quantified at the time of trading and cannot be hedged once a trade is initiated.