The Advantages and Disadvantages of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, perpetual futures, or 'perps', are often the first topic that comes up. These derivatives contracts allow traders to control large positions with minimal 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 due to the illiquidity of dated futures and the spot market. CoinDesk spoke with traders who thrive in the perpetual futures market to understand what sets perps apart, how they cater to both institutional and retail traders, and the costs associated with perps trading. The traders' responses highlighted the deep liquidity, low fees, and efficient margin usage of perps. However, they also expressed concerns about funding rates, which are recurring costs for maintaining open positions. Funding rates are essentially interest charges that accumulate over time and can significantly impact traders' profits. To understand why perps are so popular, it's essential to consider the daily volume of over $200 billion. Traders attribute this to the necessity of using perps, particularly for cryptocurrencies other than Bitcoin and Ether, where dated futures liquidity is limited. Lucas Krenn, a derivatives trader, noted that perps are the primary tool for crypto-native firms due to their liquidity and efficiency. Kenneth Ong, an independent trader, emphasized the benefits of perps for retail traders, including better fills, lower fees, and the ability to run both long and short positions simultaneously. Both traders praised the margin efficiency of perps, which allows for greater trading exposure with minimal collateral. 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 tokenized commodities, such as oil, during non-traditional hours. However, traders are wary of the funding rate, which can be a significant burden for those holding positions for extended periods. The funding rate is unquantifiable at the time of trade and cannot be hedged, making it a considerable risk for traders. The issue of funding rates is further complicated by the socialization of losses on crypto exchanges, which can lead to the forced closure of profitable positions. Krenn argued that this is not a problem with perps themselves but rather with the crypto exchange margin model. He emphasized that the key distinction is between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn also pointed out that being long is the structurally safer side due to the ease of arbitraging away positive funding. In contrast, negative funding rates can persist for extended periods, making the short side riskier. The asymmetry between long and short positions is often not accounted for in risk models, and funding rates can remain extremely high or low for a long time. In conclusion, perps have democratized futures trading by addressing issues of access, cost, and margin efficiency. However, they are not without unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn noted, the whole market is carrying an interest rate exposure that it cannot price or hedge until a liquid dated curve in crypto is established.