The Double-Edged Sword of Perpetual Futures: Insights from Crypto Traders

Discussing crypto trading with experienced traders often leads to conversations about perpetual futures, or 'perps', which are derivative contracts allowing traders to control large positions with minimal capital. Perps function similarly to standard futures but lack an expiry date. For traders of alternative cryptocurrencies, perps are often the primary derivatives option due to the illiquidity of dated futures and the spot market being less relevant for non-long-term holders. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart, how they cater to both institutional and retail traders, and the associated costs. The traders unanimously praised perps for their deep liquidity, low trading fees, and high margin efficiency, which enables significant trading exposure with minimal collateral. However, they also expressed concern over funding rates, a recurring cost for maintaining open positions, likening it to an interest charge that accumulates over time. The reason for the widespread adoption of perps, with daily volumes exceeding $200 billion, is attributed to necessity rather than choice, particularly for assets outside of Bitcoin and Ethereum, where dated futures lack liquidity. Lucas Krenn, a derivatives trader, emphasized that perps are not just one tool among many but the fundamental instrument for crypto-native firms due to their liquidity and efficiency. Kenneth Ong, an independent trader, highlighted the advantages of perps for retail traders, including better order execution, lower fees, and the ability to hold both long and short positions simultaneously. Both traders stressed that margin efficiency is a significant draw to perps, allowing for the management of risk across multiple venues and tokens with leverage that far surpasses standard futures. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than being limited to traditional market hours. This is particularly notable in times of significant news events, where perps allow for immediate reaction and price adjustments. Despite the advantages, traders are wary of the funding rate, which can become a substantial burden if not properly managed. The funding rate, which is charged every eight hours, can lead to unforeseen expenses, especially for long-term positions. Krenn and Ong warned that the funding rate is unquantifiable at the point of trade and cannot be hedged once the position is opened, making it a significant risk factor. The issue of funding rates is further complicated by the lack of a built-in mechanism to lock in interest rates, leaving traders exposed to floating rates. The traders also discussed the concept of 'perpification' of assets, where perps become the primary trading instrument for various assets, potentially replacing dated futures. This trend is expected to gain momentum, with tokenized commodities and equities likely to follow. However, the funding rate remains a critical concern, with the potential to erode profits if not carefully managed. In conclusion, while perps have democratized access to futures trading by addressing issues of cost, access, and margin efficiency, they introduce unique challenges, particularly the volatile funding rate exposure that cannot be 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.