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 comes up. These derivatives contracts enable traders to control larger positions with less capital. Unlike standard futures, perps do not have an expiration date, making them a popular choice among traders. For altcoin traders, perps are often the only viable option for derivatives trading, as dated futures for these assets are typically illiquid. The spot market, on the other hand, is often an afterthought for traders who don't plan to hold onto their assets long-term. Traders who have found success in the perpetual futures market point to the deep liquidity, low trading fees, and efficient margin usage as major advantages. However, they also express concerns over the funding rates, which can add up over time and eat into their profits. So, why do traders prefer perps? The answer lies in their necessity. For crypto-native firms, perps are not just one tool among many, but the primary tool for trading. Dated futures, on the other hand, are often illiquid and require costly replacements at expiration. Perps offer better fills, lower fees, and the ability to run both long and short positions simultaneously. This is particularly advantageous for retail traders, who can take advantage of the hedge mode to hold both bullish and bearish bets on the same token. The margin efficiency of perps is also a major draw, as it allows traders to manage risk across different venues and tokens. Because perps require only a fraction of the position's value as collateral, traders can split their capital across multiple venues and still maintain meaningful positions. The perpetual nature of perps has also shifted the dynamics of price discovery, allowing it to occur at any time, rather than just during market hours. This has been particularly evident in the tokenized oil trading market, where perps have enabled traders to react quickly to news and events. However, perps are not without their challenges. The funding rate, which is typically charged every eight hours, can be a significant burden for traders who hold positions for extended periods. This rate can be difficult to quantify and hedge, making it a major concern for traders. The lack of a built-in mechanism to lock in the funding rate exposes traders to floating rates, which can be detrimental to their profits. Furthermore, the funding rate can be volatile, making it challenging for traders to predict and manage their costs. Despite these challenges, perps are likely to continue gaining popularity in the coming years. As the liquidity of perps deepens across commodities and equities, it may eventually replace dated futures as the primary venue for derivatives trading. However, traders must be aware of the unique pain points associated with perps, particularly the funding rate exposure, which can be difficult to quantify and hedge. As one trader put it, 'Until there is a liquid dated curve in crypto, the whole market is carrying an interest rate exposure it cannot price and cannot hedge.' In conclusion, perps have democratized futures trading by solving the problems of access, cost, and margin efficiency. However, they are not without their unique challenges, and traders must be aware of the potential risks and costs associated with these contracts.