Understanding the Pros and Cons of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' often comes up. These derivatives contracts allow traders to control large positions with minimal capital. Unlike standard futures, perps do not have an expiration date, making them a unique and attractive option for traders. For altcoin traders, perps are often the only viable avenue for derivatives trading, as dated futures for these assets are typically illiquid. CoinDesk spoke with traders who have thrived in the perps market to explore what sets them apart from other derivatives and how they cater to the needs of both institutional and retail traders. The traders unanimously praised perps for their deep liquidity, low trading fees, and efficient margin usage, which enables them to manage risk effectively. However, they also expressed concerns about the funding rates, a recurring cost associated with keeping positions open. 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. To understand the appeal of perps, it's essential to consider the limitations of dated futures. Lucas Krenn, a derivatives trader at STS Digital, noted that dated futures for assets other than bitcoin and ether are often illiquid, 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. Both traders emphasized the importance of margin efficiency in perps, which allows them to manage risk across multiple venues and tokens. The perpetual nature of perps has also shifted the dynamics of price discovery, enabling traders to react to news and events in real-time, rather than being limited to traditional market hours. Ong recalled an instance during the Iran conflict, where tokenized oil trading on Hyperliquid saw a significant surge in volume, demonstrating the power of perps in facilitating price discovery. Krenn and Ong also discussed the potential for perps to gain traction in other asset classes, such as commodities and equities, as they offer a more efficient and liquid way to trade. However, they cautioned about the risks associated with funding rates, which can be unpredictable and difficult to hedge. The traders noted that while liquidations are often cited as a concern, funding rates are a more significant issue, as they can erode profits over time. Krenn explained that the funding rate is unquantifiable at the point of trade and unhedgeable afterwards, making it a significant risk for traders. Ong warned that ignoring funding rates can lead to losses, even on profitable trades. The traders also addressed the criticism that perps faced during the October 10 crash, which triggered widespread deleveraging. Krenn argued that the issue was not with perps themselves but rather with the crypto exchange margin model, which socializes losses onto winners. He emphasized that the distinction between perpetual and dated futures is not the primary concern; instead, it's the presence of a proper clearing house with a mutualized default fund that matters. Krenn offered an interesting insight, suggesting that being long is the structurally safer side in perps, as positive funding is easy to arbitrage away. However, when the funding rate is negative, the arbitrage is more complex, and the gap between perp and spot prices can persist. This asymmetry is often overlooked in risk models, and Krenn pointed to the example of Euler's token, where funding rates became extremely negative due to a small and concentrated float. In conclusion, perps have democratized futures trading by providing access, cost efficiency, and margin efficiency, but they also come with unique challenges, such as volatile funding-rate exposure. As Krenn noted, until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that cannot be priced or hedged. For now, funding rates remain the 'tax' that everyone pays for access to this leveraged market.