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

When discussing crypto trading with experienced traders, the conversation often revolves around perpetual futures, or 'perps,' which are derivatives contracts allowing traders to control larger positions with less capital. Unlike standard futures, perps do not have an expiration date, making them a unique and attractive option for traders. For traders of alternative cryptocurrencies, perps are often the only viable derivatives market available, as dated futures for these assets are typically illiquid, and the spot market is less relevant for short-term trading strategies. CoinDesk spoke with traders who have found success in the perpetual futures market to understand what sets perps apart from other derivatives, how they cater to the needs of both institutional and retail traders, and the associated costs of perps trading. The consensus among traders is that perps are favored due to their deep liquidity, low trading fees, and high margin efficiency, which enables traders to maximize their exposure with minimal collateral. However, traders also highlighted the funding rate as a significant concern, which is a recurring cost for maintaining open positions. This funding rate can be seen as an interest charge that accumulates over time, and traders are worried about its potential impact on their profitability. The popularity of perps can be attributed to their necessity in the crypto market, particularly for assets other than Bitcoin and Ethereum, where dated futures lack liquidity. Lucas Krenn, a derivatives trader, emphasized that perps are not just one tool among many but are the primary instrument for crypto-native firms due to the illiquidity of standard dated futures. The liquidity of perps allows for better execution of trades, reducing slippage and improving overall trading efficiency. Independent trader Kenneth Ong shared a similar perspective, highlighting the benefits of perps for retail traders, including better fills, lower fees, and the ability to hold both long and short positions simultaneously through hedge mode. This flexibility is particularly advantageous compared to regulated venues like the CME, where positions are typically netted by default. Both Krenn and Ong stressed that margin efficiency is a key draw to perps, enabling traders to manage risk more effectively across different venues and tokens. 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 evident in the trading activity during significant events, such as the Iran conflict, where perps saw a surge in volume while traditional markets were closed. Traders believe that the perpification of various assets will continue to gain momentum, with tokenized oil trading being a precursor to what's to come for other commodities. Despite the advantages, traders are cautious about the funding rate, which can be a significant burden if not managed properly. The funding rate for perps changes over time and is typically charged every eight hours, leaving traders exposed to floating rates without a built-in mechanism to lock in their costs. This unpredictability makes it challenging for traders to quantify and hedge against funding rate risks. The issue of liquidations, particularly during the October 10 crash, highlighted the risks associated with perps, but traders argue that this is more a problem of crypto exchange margin models rather than an inherent flaw in perps themselves. Krenn pointed out that the distinction between perpetual and dated futures is less relevant than the difference between facing a proper clearing house with a mutualized default fund and an exchange that socializes losses onto winners. He also noted that being long is structurally safer due to the ease of arbitraging away positive funding, whereas negative funding rates can persist due to constraints in shorting the underlying token. This asymmetry is often overlooked in risk models, leading to unforeseen exposures. In conclusion, while perps have democratized access to futures trading by addressing issues of access, cost, and margin efficiency, they also 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 to navigate the perpetual futures landscape effectively.