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

Discussing crypto trading with experienced traders often leads to conversations about perpetual futures, or 'perps', which are derivative contracts allowing traders to control larger positions with less capital. Unlike standard futures, perps have no expiration date. For traders of alternative cryptocurrencies, perps are often the only viable option for derivatives trading due to illiquid dated futures and spot markets. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart, how they cater to both institutional and retail traders, and the associated costs. The traders unanimously praised perps for their deep liquidity, low trading fees, and efficient margin usage, which enables significant trading exposure with minimal collateral. However, they also expressed concern over funding rates, a recurring cost for maintaining open positions. Funding rates are essentially interest charges that accrue over time and can substantially add up. The traders attributed the popularity of perps, with daily volumes exceeding $200 billion, to necessity rather than choice. Lucas Krenn, a derivatives trader, stated that perps are the foundation of his firm's operations, particularly for cryptocurrencies other than Bitcoin and Ether, where dated futures lack liquidity. Kenneth Ong, an independent trader, highlighted the advantages of perps for retail traders, including better order execution, lower fees, and the ability to hold both long and short positions simultaneously. Both traders emphasized margin efficiency as a key benefit of perps, allowing for the management of risk across multiple venues and tokens with minimal capital. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than being limited to traditional market hours. This is particularly significant for tokenized assets, where perps can provide a more efficient and accessible way to trade. Despite the advantages, traders are wary of the funding rate, which can be unpredictable and costly. Krenn and Ong consider the funding rate a more significant concern than liquidations, as it can erode profits over time. The funding rate is typically charged every eight hours and can fluctuate, leaving traders exposed to floating rates without a mechanism to lock them in. The traders also addressed the criticism of perps following the October 10 crash, which triggered widespread deleveraging. Krenn argued that the issue was not with perps themselves but with the crypto exchange margin model, which socializes losses onto profitable traders. He emphasized that the key distinction is between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses. Krenn also offered an insight into the asymmetry of perp risk, suggesting that being long is structurally safer due to the ease of arbitraging away positive funding. However, when funding rates are negative, arbitrage is more complex, and the gap between perp and spot prices can persist. This asymmetry is often overlooked in risk models. In conclusion, while perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, they are not without unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged.