The Double-Edged Sword of Perpetual Futures in Crypto Trading

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 large positions with minimal capital. Unlike standard futures, perps do not have an expiry 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 assets are typically illiquid, and the spot market is not a primary focus for those who don't plan to hold long-term. CoinDesk spoke with traders who have thrived in the perps market to understand what sets them apart from other derivatives, how they cater to both institutional and retail traders, and the associated costs. The traders' responses highlighted the deep liquidity, low trading fees, and efficient margin usage of perps. However, they also expressed concerns over funding rates, which are recurring costs for maintaining open positions. Funding rates can be thought of as interest charges that accumulate over time, and traders are worried about their potential impact. So, why do traders prefer perps? The answer lies in their necessity. With dated futures lacking liquidity, especially for assets beyond bitcoin and ether, perps have become the go-to tool for many traders. Lucas Krenn, a derivatives trader, and Kenneth Ong, an independent trader, both emphasized the importance of perps in their trading strategies. Krenn noted that perps are not just one tool among many but are instead the primary tool for crypto-native firms. Ong, who has most of his trading activity in perps, highlighted their benefits, including better fills, lower fees, and the ability to run both long and short positions simultaneously. Both traders agreed that margin efficiency is a significant draw for perps, allowing them to manage risk effectively across different venues and tokens. Perps have also shifted price discovery, enabling traders to react to news and events in real-time, rather than waiting for traditional market hours. However, traders are cautious about the funding rate, which can be a significant burden, especially for long-term positions. Unlike dated futures contracts, which have a fixed interest rate, perps have a funding rate that changes over time and is typically charged every eight hours. This exposes traders to a floating rate, making it challenging to quantify and hedge. Krenn and Ong both expressed concerns over the funding rate, with Ong stating that it can potentially turn a profitable trade into a loss. The recent bitcoin bear market has also highlighted the risks associated with perps, particularly during times of high market volatility. While perps have been criticized for their role in amplifying losses, Krenn argues that the issue lies not with perps themselves but with the crypto exchange margin model. He believes that the distinction between perps and dated futures is not the primary concern; instead, it is whether traders are facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn also offered an interesting insight into the asymmetry of perp risk, suggesting that being long is the structurally safer side. His logic is that positive funding is easy to arbitrage away, but negative funding can persist due to constraints on shorting the underlying token. This asymmetry is often not priced correctly in risk models, leaving traders exposed to potential losses. In conclusion, perps have democratized futures trading by providing access, low costs, and efficient margin usage. However, 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 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.