The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' inevitably arises. These derivative contracts enable traders to control larger positions with less capital, but they also come with unique challenges. Perps function similarly to standard futures, except they lack an expiration date. For traders of alternative cryptocurrencies, perps often represent the only viable option for derivatives trading, as dated futures for these assets tend to be illiquid. The spot market, on the other hand, is generally used for long-term holdings. To better understand the appeal and drawbacks of perps, CoinDesk spoke with traders who have thrived in this market. They highlighted the deep liquidity, low trading fees, and efficient margin usage of perps, but also expressed concerns about funding rates. Funding rates can be thought of as interest charges that accrue over time, and traders are worried about their potential impact on profitability. The daily trading volume of crypto perps exceeds $200 billion, and traders attribute this to the necessity of using perps due to the lack of liquidity in dated futures. Lucas Krenn, a derivatives trader, noted that perps are the primary tool for crypto-native firms, as they offer better liquidity and lower costs compared to dated futures. Kenneth Ong, an independent trader, echoed this sentiment, citing the advantages of perps for retail traders, including better fills, lower fees, and the ability to hold both long and short positions simultaneously. However, both traders cautioned about the risks associated with funding rates, which can be volatile and difficult to quantify. The funding rate is typically charged every eight hours and can become a significant burden if the market does not move as expected. Krenn and Ong emphasized that margin efficiency is a major draw for perps, as they allow traders to manage risk efficiently across different venues and tokens. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than only during market hours. This has led to increased trading activity in perps tied to traditional assets, such as tokenized oil. Despite the benefits of perps, traders are wary of the funding rate, which can be a significant expense for traders who hold positions for extended periods. The lack of a built-in mechanism to lock in the funding rate exposes traders to floating rates, making it challenging to hedge against potential losses. In conclusion, while perps have democratized futures trading by providing access, cost savings, and margin efficiency, they also come with unique challenges, particularly the volatile funding-rate exposure. As Krenn noted, the whole market is carrying an interest rate exposure that cannot be priced or hedged until a liquid dated curve emerges in crypto.