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

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' often comes up. These derivatives contracts allow traders to control larger positions with less capital. Perps function similarly to standard futures but without an expiry date. For traders of alternative cryptocurrencies, perps are often the only viable option for derivatives trading, as dated futures for these assets are typically illiquid, and the spot market is not ideal for short-term trading. CoinDesk spoke with traders who have excelled 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 unanimously praised perps for their deep liquidity, low trading fees, and high margin efficiency, which enables them to manage risk effectively. However, they also expressed concerns about funding rates, a recurring cost for maintaining open positions. Funding rates can be thought of as an interest charge that accrues over time, and traders are worried about the potential impact on their profits. The popularity of perps can be attributed to their necessity, particularly for traders of alternative cryptocurrencies. Lucas Krenn, a derivatives trader at STS Digital, noted that perps are the primary tool for crypto-native firms, as dated futures lack liquidity outside of bitcoin and ether. Kenneth Ong, an independent trader, highlighted the benefits of perps for retail traders, including better fills, lower fees, and the ability to hold both long and short positions simultaneously. Both Krenn and Ong emphasized the importance of margin efficiency in perps, which allows traders to manage risk across multiple venues and tokens with a single pool of capital. 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 advantages of perps, traders are cautious about the funding rate, which can be a significant burden for traders who hold positions for extended periods. The funding rate is unquantifiable at the time of trade and cannot be hedged, making it a concern for traders. The recent bear market in bitcoin has also highlighted the risks associated with perps, particularly the socialization of losses on exchanges. However, Krenn argued that the issue lies with the crypto exchange margin model, rather than perps themselves. He noted that the distinction between perpetual and dated futures is less important than the presence of a proper clearing house with a mutualized default fund. Krenn also pointed out that being long is often the structurally safer side in perps, as positive funding can be arbitraged away, while negative funding can persist due to constraints on shorting the underlying token. The funding rate can remain extremely high or low for extended periods, making it challenging for traders to manage their risk. In conclusion, perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, but 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 cannot be priced or hedged, making funding a 'tax' that everyone pays for access to this leveraged market.