When discussing crypto trading with experienced traders, the conversation often revolves around perpetual futures, or 'perps' - a type of derivatives contract that enables traders to control large positions with minimal capital. Unlike standard futures, perps do not have an expiration date, making them a popular choice among traders. For altcoin traders, perps are often the only viable option for derivatives trading, as dated futures contracts for these assets are typically illiquid. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart from other derivatives and how they cater to the needs of both institutional and retail traders.
The traders unanimously praised perps for their deep liquidity, low trading fees, and efficient margin usage, which allows for greater trading exposure with less collateral. However, they also expressed concerns over the funding rates associated with perps, which can add up over time and eat into profits.
So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the backbone of their trading operations, particularly for assets other than bitcoin and ether, where dated futures contracts are scarce.
Krenn noted that dated futures contracts are often replaced with new contracts at expiration, resulting in additional costs that can make them less efficient. Perps, on the other hand, offer better liquidity, allowing traders to enter and exit positions more easily. Kenneth Ong, an independent trader, echoed Krenn's sentiments, highlighting the advantages of perps for retail traders, including better fills, lower fees, and the ability to hold both long and short positions simultaneously.
Ong also emphasized the importance of margin efficiency in perps, which enables traders to manage risk more effectively across different venues and assets. One of the key benefits of perps is their ability to provide price discovery around the clock, rather than just during market hours.
This is particularly significant for assets like tokenized oil, which can be traded on perps even when traditional markets are closed. The always-on nature of perps has shifted price discovery to occur whenever news breaks, rather than just during market hours.
However, perps also come with unique challenges, particularly with regards to funding rates. Funding rates are essentially interest charges that accrue over time, and can be a significant burden for traders who hold positions for extended periods. Krenn and Ong both expressed concerns over funding rates, which can be difficult to quantify and hedge. According to Krenn, the funding rate is a more significant concern than liquidations, as it can be a persistent and unpredictable cost that can erode profits over time.
Ong was more blunt, stating that funding rates can 'potentially balloon to the point where a profitable trade loses money.' The issue of funding rates is further complicated by the fact that perps are often traded on crypto exchanges, which can socialize losses onto winners during times of market stress. This can result in profitable trades being force-closed, even if the trader has sufficient capital to cover their positions.
Krenn argued that this is not a problem with perps themselves, but rather with the exchange's margin model and insurance fund. In fact, Krenn believes that being long is often the structurally safer side in perps, as positive funding rates can be arbitraged away by traders who buy spot and sell perps.
However, when funding rates are negative, the arbitrage process is more difficult, and the gap between perp and spot prices can persist, resulting in funding rates that can stay extremely negative for long periods. This asymmetry can have significant implications for traders, as the long side has a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost.
In conclusion, while perps have democratized futures trading by providing access, cost efficiency, and margin efficiency, they also come with unique challenges, particularly with regards to funding rates. As Krenn put it, 'until there is a liquid dated curve in crypto, the whole market is carrying an interest rate exposure it cannot price and cannot hedge.' For now, funding rates remain the 'tax' that everyone pays for easy access to this leveraged market.