When discussing crypto trading with experienced traders, the conversation often centers around perpetual futures, or 'perps,' which are derivative contracts allowing for larger position control with less capital. Unlike standard futures, perps do not have an expiration date, making them a unique and popular choice among traders. For altcoin traders, perps are frequently the only viable option for derivatives trading due to the illiquidity of dated futures and the spot market.
CoinDesk spoke with traders who have found success 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 unanimously agreed that perps are appealing due to their deep liquidity, low trading fees, and high margin efficiency, which enables greater trading exposure with less collateral. However, they also highlighted a significant recurring cost: funding rates, essentially an interest charge that accumulates over time. The reason perps see an average daily volume of over $200 billion, according to traders, is not by choice but by necessity.
Lucas Krenn, a derivatives trader, explained that outside of bitcoin and ether, dated futures lack sufficient liquidity, making perps the primary tool for crypto-native firms. Dated futures are less popular because they need to be replaced at expiration, incurring additional costs, which also affects the efficiency of futures-based ETFs.
Perps, on the other hand, offer better liquidity, allowing for large buy and sell orders without significantly impacting prices. Kenneth Ong, an independent trader, shared a similar perspective, emphasizing that perps provide better order execution, lower fees, and the ability to hold both long and short positions simultaneously through hedge mode.
This flexibility is a significant advantage over regulated venues like the CME, where accounts are typically netted by default. Both Ong and Krenn stressed that margin efficiency is the primary draw to perps, enabling traders to manage risk more effectively 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 maintain meaningful positions. The perpetual nature of perps has also shifted price discovery to occur around the clock, not just during market hours. This was evident during the Iran conflict, where significant price movements occurred over the weekend when traditional markets were closed. Traders like Ong found that perps allowed for immediate reaction to news, with a chunk of the repricing happening before traditional markets opened.
Krenn noted that this mechanism applies to perps tied to traditional assets as well, making them a powerful tool for traders. However, both traders expressed concern over funding rates, which can become a significant burden if not managed properly.
Unlike dated futures contracts, which have a fixed interest rate, perpetual futures contracts 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 the cost at the time of the trade and hedge against it afterward. The traders warned that funding rates are not a minor issue and can potentially turn a profitable trade into a loss if positions are held for extended periods. The issue of funding rates is particularly problematic because it is unquantifiable at the point of trade and cannot be hedged once the position is open.
This concern was underscored by the events following the October 10 crash, where widespread deleveraging led to the forced closure of both losing and profitable positions. While perpetual futures faced criticism, Krenn argued that the problem lies not with perps but with the crypto exchange margin model, which socializes losses onto winners.
He emphasized that the distinction between perpetual and dated futures is less relevant than whether traders are facing a proper clearing house with a mutualized default fund or an exchange that socializes losses. Krenn also offered an interesting insight into the risk profile of perps, suggesting 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 a situation where the gap between perp and spot prices can persist, resulting in funding rates staying extremely negative for extended periods. This asymmetry, where the long side has a bounded cost and unbounded upside, while the short side has a bounded upside and unbounded cost, is not adequately accounted for in most risk models.
In conclusion, while perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, they introduce unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn noted, 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' for participating in this leveraged market.