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

Discussing crypto trading with experienced traders often leads to conversations about perpetual futures, or 'perps' - a type of derivatives contract that allows traders to control larger positions with less capital. These contracts function similarly to standard futures but lack an expiry date. For traders of alternative cryptocurrencies, perps are often the primary means of accessing derivatives markets, as dated futures for these assets are typically illiquid. CoinDesk consulted 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 trading perps. The traders' responses highlighted the deep liquidity, low trading fees, and efficient margin usage of perps as key benefits. However, they also expressed concern over funding rates, which are recurring costs for maintaining open positions. Funding rates can be thought of as interest charges that accumulate over time, and traders are worried about their potential impact on trading costs. The popularity of perps can be attributed to their necessity, particularly for assets other than bitcoin and ether, where dated futures lack liquidity. Lucas Krenn, a derivatives trader, noted that perps are the primary tool for crypto-native firms due to the illiquidity of dated futures. Kenneth Ong, an independent trader, shared a similar perspective, emphasizing the advantages of perps for retail traders, including better execution prices, lower fees, and the ability to hold both long and short positions simultaneously. Both traders cited margin efficiency as a significant draw to perps, allowing for the management of risk across multiple venues and tokens with a single pool of capital. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than being limited to traditional market hours. This has been observed in the trading of tokenized commodities, such as oil, where significant price movements have occurred outside of traditional market hours. Despite the benefits of perps, traders are cautious about the funding rate, which can be unpredictable and difficult to hedge. A dated futures contract provides a clear interest rate, whereas a perpetual futures contract has a funding rate that changes over time, typically charged every eight hours. This exposes traders to a floating rate, making it challenging to quantify and hedge. The funding rate can become a significant burden if the market does not move as expected, potentially turning a profitable trade into a loss. The issue of funding rates is further complicated by the lack of a liquid dated curve in crypto, leaving the market vulnerable to interest rate exposure that cannot be priced or hedged. As the crypto market continues to evolve, the role of perps is likely to remain significant, but traders must be aware of the unique challenges and risks associated with these contracts.