The Dual Nature of Perpetual Futures: Benefits and Drawbacks According to Crypto Traders

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' inevitably arises. These derivatives contracts enable traders to control larger positions with less capital, offering an advantage over traditional futures due to their lack of expiry dates. For traders of alternative cryptocurrencies, perps are often the primary avenue for derivatives trading, as dated futures for these assets are typically illiquid. The spot market, on the other hand, is often an afterthought for traders who don't plan on holding their positions long-term. To better understand the appeal and challenges of perps, insights were gathered from traders who have found success in the perpetual futures market. Their responses highlighted the deep liquidity, low trading fees, and efficient margin usage of perps as key benefits. However, they also expressed concerns about funding rates, which are recurring costs associated with keeping positions open. These rates can add up over time and are a significant consideration for traders. The popularity of perps can be attributed to their necessity in the crypto market. According to Lucas Krenn, a derivatives trader, perps are the foundation of his firm's operations, particularly for assets other than Bitcoin and Ethereum, where dated futures lack liquidity. Kenneth Ong, an independent trader, shared a similar perspective, noting that perps offer better execution prices, lower fees, and the ability to hold both long and short positions simultaneously. The advantage of perps over traditional futures lies in their ability to provide higher leverage, allowing traders to manage risk more efficiently across different venues and tokens. 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 being limited to traditional market hours. This was evident during the Iran conflict, where tokenized oil trading saw significant activity on weekends, while traditional markets were closed. Traders like Krenn and Ong believe that the 'perpification' of various assets will continue to gain momentum, potentially replacing dated futures altogether. However, they also cautioned about the risks associated with perps, particularly the funding rate, which can be a significant burden for traders who hold positions for extended periods. Unlike dated futures contracts, which have a fixed interest rate, perps have a funding rate that changes over time and is typically charged every eight hours. This exposes traders to a floating rate, making it challenging to quantify and hedge against. The funding rate can potentially turn a profitable trade into a loss, especially for traders who hold positions for long periods. The issue of funding rates is further complicated by the lack of a built-in mechanism to lock in rates and the difficulty in hedging against them. As Krenn noted, the funding rate is 'unquantifiable at the point of trade and unhedgeable afterwards.' The concerns surrounding perps were also highlighted during the October 10 crash, which triggered widespread deleveraging across both losing and profitable positions. While perps faced criticism, Krenn argued that the issue was not with perps themselves, but rather with the crypto exchange margin model. He emphasized that the distinction between perpetual and dated futures is not as significant as the difference between facing a proper clearing house with a mutualized default fund and an exchange that socializes losses onto winners. Krenn also offered an insight that challenges the common assumption about perp risk, suggesting that being long is the structurally safer side. His logic is based on the idea that positive funding is easy to arbitrage away, whereas negative funding is more challenging to address due to the constraints on shorting the underlying token. This asymmetry can lead to funding rates remaining extremely negative for extended periods, making the long side have a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost. 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. As Krenn put it, 'Until there is a liquid dated curve in crypto, the whole market is carrying an interest rate exposure it cannot price and cannot hedge.'