The Double-Edged Sword of Perpetual Futures: Benefits and Drawbacks

When discussing cryptocurrency trading with experienced traders, the conversation often revolves around perpetual futures, or 'perps' - a type of derivative contract that enables traders to control large positions with minimal capital. Perps function similarly to standard futures but lack an expiration date. For traders of alternative cryptocurrencies, perps are often the only viable option for derivatives trading, as dated futures contracts for these assets are typically illiquid, and the spot market is not a viable option for those who don't plan to hold their assets long-term. 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 overwhelmingly positive, citing deep liquidity, low trading fees, and efficient margin usage as the primary advantages of perps. However, they also expressed concerns over funding rates, which are recurring costs incurred for maintaining open positions. Funding rates can be thought of as interest charges that accumulate over time, and traders are worried about the potential impact on their profits. The popularity of perps can be attributed to their necessity, rather than choice, according to Lucas Krenn, a derivatives trader at market-making firm STS Digital. Krenn explained that outside of bitcoin and ether, dated futures contracts lack liquidity, making perps the primary tool for crypto-native firms. Kenneth Ong, an independent trader, shared a similar perspective, highlighting the benefits of perps for retail traders, including better fills, lower fees, and the ability to hold both long and short positions simultaneously. Ong noted that perps offer a significant advantage over regulated venues like the CME, which typically net positions by default. Both Krenn and Ong emphasized that margin efficiency is a major draw for perps, allowing traders to manage risk effectively across different venues and tokens. The perpetual nature of perps has also shifted price discovery, enabling it to occur at any time, rather than only during market hours. This has been particularly evident in the context of tokenized oil trading, where perps have allowed for more efficient price discovery. However, traders also warned about the risks associated with perps, particularly the funding rate, which can be a significant burden for traders who hold positions for extended periods. Krenn and Ong cautioned that the funding rate can be unquantifiable and unhedgeable, making it a major concern for traders. The issue of funding rates is further complicated by the fact that perps are often used as a tool for price discovery, which can lead to unpredictable funding rates. In conclusion, while perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, they also introduce unique challenges, such as volatile funding-rate exposure. As Krenn noted, the crypto market is currently carrying an interest rate exposure that it cannot price or hedge, making funding a 'tax' that everyone pays for access to this leveraged market.