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

When discussing crypto trading with experienced traders, perpetual futures, or 'perps,' are often the first topic that comes up. These derivatives contracts enable traders to control large positions with minimal capital, offering a key advantage over traditional futures: they never expire. For traders of alternative cryptocurrencies, perps are frequently the only available derivatives option, as dated futures contracts for these assets are often illiquid. CoinDesk spoke with traders who have thrived in the perps market to understand what sets them apart from other derivatives, how they cater to the needs of institutional and retail traders, and the costs associated with perps trading. The traders' responses were unanimous: perps are popular due to their deep liquidity, low trading fees, and high margin efficiency. However, they also expressed concerns about funding rates, which are recurring costs for maintaining open positions. Funding rates can be thought of as interest charges that accumulate over time, and traders are worried about their potential impact on profitability. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the foundation of his firm's operations. 'Outside of bitcoin and ether, dated futures liquidity is thin to the point of being unusable,' he explained. 'Perps are not just one tool among many; for a crypto-native firm, they are the primary tool.' 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 run both long and short positions simultaneously. Ong noted that perps offer a significant advantage over traditional futures, as they allow traders to hold both bullish and bearish bets on the same token in the same account. Both Krenn and Ong emphasized that margin efficiency is a major draw for perps. Since perps require only a fraction of a position's value as collateral, traders can split their capital across multiple venues and tokens, efficiently managing risk. The perpetual nature of perps has also shifted price discovery to a 24/7 process, allowing traders to react to news and events as they happen, rather than being limited to traditional market hours. However, perps are not without their challenges. Traders are concerned about funding rates, which can be volatile and difficult to predict. A dated futures contract provides a clear interest rate from the outset, whereas a perpetual futures contract has a funding rate that changes over time, typically charged every eight hours. This exposes traders to a floating rate, making it difficult to quantify and hedge against. Krenn and Ong warned that funding rates can become a significant burden, especially for traders who hold positions for extended periods. The traders also discussed the 'myth of the safe trade,' highlighting the risks associated with perps, particularly during times of high market volatility. In October last year, a market crash triggered widespread deleveraging, resulting in the forced closure of both profitable and unprofitable positions. While perps faced criticism, Krenn argued that the issue was not with the perps themselves, but rather with the crypto exchange margin model. He emphasized that the key distinction is not between perpetual and dated futures, but rather between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn also offered an insight that challenges conventional wisdom about perp risk, suggesting that being long is structurally safer due to the ease of arbitraging away positive funding. However, when funding rates are negative, the arbitrage process is more complex, and the gap between perp and spot prices can persist, leading to extremely negative funding rates. In conclusion, perps have democratized futures trading by addressing issues of access, cost, and margin efficiency. Nevertheless, they are not without unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn noted, 'Until there is a liquid dated curve in crypto, the whole market is carrying an interest rate exposure it cannot price and cannot hedge.' For now, funding remains the 'tax' everyone pays for easy access to this leveraged market.