The Double-Edged Sword of Perpetual Futures: Benefits and Drawbacks According to Crypto Traders

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' often comes up. These derivatives contracts allow traders to control larger positions with less capital, functioning similarly to standard futures but without an expiry date. For altcoin traders, perps are frequently the only viable option for derivatives trading, given the illiquidity of dated futures and the spot market's limitations. To understand what makes perps unique and how they cater to both institutional and retail traders, insights from traders who have thrived in the perpetual futures market are invaluable. Their feedback highlights the appeal of perps due to their deep liquidity, low trading fees, and high margin efficiency, which enables significant trading exposure with minimal collateral. However, traders also express concerns over funding rates, a recurring cost for maintaining open positions that can accumulate over time. The necessity of perps is underscored by their average daily volume exceeding $200 billion, with traders attributing this to the lack of viable alternatives, particularly for assets beyond bitcoin and ether. Lucas Krenn, a derivatives trader, notes that outside of bitcoin and ether, dated futures lack sufficient liquidity, making perps an indispensable tool for crypto-native firms. Kenneth Ong, an independent trader, echoes this sentiment, emphasizing the benefits of perps for retail traders, including better trade executions, lower fees, and the ability to hold both long and short positions simultaneously through hedge mode. Both traders agree that margin efficiency is a significant draw to perps, allowing for the management of risk across various venues and tokens with greater leverage than standard futures. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than being confined to traditional market hours. This is exemplified by the reaction to the Iran conflict, where significant price movements occurred in crypto and tokenized commodity perps over a weekend, prior to the opening of traditional markets. The traders foresee the continued growth of perps into new asset classes, driven by their liquidity and efficiency. Nonetheless, they caution against the risks associated with funding rates, which can be volatile and unpredictable. 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, leaving traders exposed to floating rates without a mechanism to lock them in. This concern is compounded by the challenge of quantifying and hedging funding rate exposure. The traders also address the misconception that perps are inherently risky, pointing out that issues such as liquidations are more closely related to exchange margin models and the socialization of losses rather than the nature of perps themselves. Furthermore, Krenn highlights an often-overlooked asymmetry in perp risk, where being long is structurally safer due to the ease of arbitraging away positive funding rates, whereas negative funding rates can persist due to constraints in shorting the underlying token. This asymmetry implies that long positions have bounded costs but unbounded upside, while short positions have bounded upside but unbounded costs, an insight that is rarely accounted for in risk models. In conclusion, while perps have democratized access to futures trading by addressing issues of access, cost, and margin efficiency, they introduce unique challenges, most notably the volatile and unpredictable funding rate exposure that cannot be easily quantified or hedged. As the crypto market continues to evolve, understanding and managing these risks will be crucial for traders navigating the perpetual futures landscape.