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, but they also come with unique challenges. Perps work similarly to standard futures, but without an expiration date.
For traders of alternative cryptocurrencies, perps may be the only available derivatives option, as dated futures for these assets are often illiquid. CoinDesk spoke with traders who have succeeded in the perps market to understand what makes them distinct from other derivatives and how they meet the needs of both institutional and retail traders. The traders emphasized the deep liquidity, low trading fees, and high margin efficiency of perps, which enable traders to manage risk effectively. However, they also expressed concerns about funding rates, which are recurring costs associated with keeping positions open.
Funding rates can be thought of as interest charges that accumulate over time, and traders are worried about their potential impact on profitability. To understand why perps are so popular, it's essential to consider the limitations of dated futures. According to Lucas Krenn, a derivatives trader at STS Digital, dated futures for assets other than Bitcoin and Ethereum are often too illiquid to be useful.
As a result, perps have become the primary tool for many crypto traders. The liquidity of perps allows for better execution of trades, with lower slippage and more favorable prices. Kenneth Ong, an independent trader, noted that perps offer advantages such as lower fees, better fills, and the ability to hold both long and short positions simultaneously. This flexibility is particularly useful for traders who want to hedge their bets or take advantage of price discrepancies.
Both Krenn and Ong highlighted the importance of margin efficiency in perps, which enables traders to manage risk across multiple venues and assets with a single pool of capital. The perpetual nature of perps has also changed the way price discovery occurs, as traders can react to news and events in real-time, rather than waiting for traditional markets to open. This has led to a shift towards perps as a primary venue for trading, especially for assets that are not widely available on traditional exchanges. Despite the benefits of perps, traders are concerned about the funding rate, which can be volatile and difficult to predict.
The funding rate is typically charged every eight hours and can add up over time, potentially eroding profitability. Krenn and Ong emphasized that the funding rate is a significant risk factor that traders need to consider when using perps. In addition to the funding rate, traders also need to be aware of the potential for liquidations, which can occur when the market moves against them.
However, Krenn argued that the problem of liquidations is not unique to perps and can occur with any type of derivatives contract. The key distinction, according to Krenn, is between exchanges that use a proper clearing house with a mutualized default fund and those that socialize losses onto winners.
The asymmetry of risk in perps is another important consideration, as Krenn noted that being long is often the structurally safer side. This is because positive funding rates can be arbitraged away, while negative funding rates can persist for extended periods, leading to significant costs for short sellers. In conclusion, perps have democratized futures trading by providing access to a leveraged market with low costs and high margin efficiency. However, they also come with unique challenges, such as volatile funding-rate exposure, which can be difficult to quantify and hedge.
As the crypto market continues to evolve, it's essential for traders to understand the pros and cons of perps and to develop strategies that mitigate their risks.