The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the conversation often turns to perpetual futures, also known as 'perps.' 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 altcoins, perps are often the only viable option for derivatives trading, as dated futures for these tokens are typically illiquid, and the spot market is not a priority for those who don't plan to hold. CoinDesk spoke with traders who have thrived 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 consensus among traders is that perps are appealing due to their deep liquidity, low trading fees, and efficient margin usage, which enables greater trading exposure with less collateral. However, traders are also concerned about the funding rates, a recurring cost for maintaining open positions. This interest charge accumulates over time and can add up significantly. Traders argue that perps are not a choice but a necessity, particularly for crypto-native firms, due to the lack of liquidity in dated futures outside of bitcoin and ether. The liquidity of perps allows for better trade execution and lower fees. Retail traders also prefer perps for their ability to offer favorable prices, lower fees, and the option to hold both long and short positions simultaneously. The real advantage of perps, according to traders, lies in their margin efficiency, which enables the management of risk across different venues and tokens with less capital. 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 price discovery to occur around the clock, rather than only during market hours. Traders have observed that significant price movements can happen outside traditional trading hours, and perps allow for more flexible trading. Despite the benefits, traders are cautious about the funding rates associated with perps. Unlike dated futures contracts, which have a fixed interest rate, perps have funding rates that change over time and are typically charged every eight hours. This exposes traders to a floating rate that cannot be locked in, making it difficult to quantify and hedge against. Traders warn that holding positions for extended periods can lead to significant funding costs, potentially turning profitable trades into losses. The issue of funding rates is particularly concerning because it is unquantifiable at the point of trade and cannot be hedged afterwards. Experienced traders emphasize that the funding rate is not a minor fee but a significant cost that can accumulate over time. The crypto market's current bear trend has also highlighted the risks associated with perps, particularly during times of high market volatility. The socialization of losses by exchanges to protect their systems has led to the liquidation of both losing and profitable positions, sparking criticism of perps. However, traders argue that this is not a problem inherent to perps but rather a result of the crypto exchange margin model. The key distinction lies not in the type of futures but in whether the exchange has a proper clearing house with a mutualized default fund. Traders also point out that being long is structurally safer due to the ease of arbitraging away positive funding rates. However, when funding rates are negative, arbitrage becomes more challenging, leading to persistent gaps between perp and spot prices. This asymmetry is often overlooked in risk models, and funding rates can remain extremely high or low for extended periods. In conclusion, while perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, they also come with unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. Until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that it cannot price or hedge, making funding a tax that everyone pays for access to this leveraged market.