Traders are making massive gains from perpetual futures contracts but there are three risks to be aware of before trading.
As tempting as it can be to buy altcoins using perpetual futures, there are a few hidden traps that one should monitor closely.
Over the past few years, numerous exchanges began to offer altcoin futures quoted in Tether (USDT) and stablecoin pairs, which eventually became the standard. This change is more convenient for most traders but still presents some serious issues for those willing to keep long positions open for more than a couple of weeks.
Before opening any trade at an exchange offering perpetual futures, traders should be aware that stronger wicks can run stop losses, investors lose the ability to stake their altcoins for lucrative yields, and the variable funding rate can significantly increase the costs of carrying a trade.
Leverage leads to stronger wicks
Regardless of how liquid a market is, leverage will result in stronger wicks. Even though these moves usually don’t lead to forced liquidation, it might run an investors’ stops.
Therefore, the possibility of errant wicks are the main reason traders should avoid carrying futures positions for more extended periods.
Futures liquidation engines use a price index composed of multiple spot (regular) exchanges to avoid price manipulation. Thus, the system will only close positions with insufficient margin once an index reaches its stops.
Take notice how ETH had a $326 low on Coinbase, while simultaneously Binance futures faced a $302 low. This change might seem small, but this certainly triggered traders’ stop orders.
There’s a way to avoid such issues, simply by setting one’s stop orders trigger to Mark Price (Index) instead of Last Price.
Making this simple change will avoid getting liquidated if futures contracts monetarily decouple from its index. The big issue is that not every exchange offers this possibility.
Staking and liquidity mining may offer a better yield
Buying altcoins using futures does not allow one to use them for staking or lending. For investors willing to carry a position for a longer-term, this is another factor to consider.
There are numerous platforms offering staking and lending services, including the top centralized exchanges. Some of the altcoins offering 30-day contract annual percentage yields (APY) that can range from 7% to 18% are Polkadot (DOT), Tron (TRX), Cosmos (ATOM), and Cardano (ADA).
Decentralized (DeFi) mining pools are another way to generate income by holding altcoins. Users should beware of this sector’s inherent risks, especially those pools with impairment loss occurring between two different cryptocurrencies.
Thus, by opting for perpetual futures, one will not be able to partake in staking and yield farming. It might not impact the decision for those betting on short-term price swings, but it weighs more as the weeks go by.
Beware of fluctuating funding rates
Perpetual contracts, also known as inverse swaps, have an embedded rate that usually charged every eight hours. Funding rates ensure there are no exchange risk imbalances. Even though both buyers and sellers open interest is matched at all times, leverage can vary.
When buyers (longs) are the ones demanding more leverage, the funding rate goes positive. Therefore, those buyers will be the ones paying up the fees. This issue holds especially true under bull run periods, when usually there’s more demand for longs.
The above chart shows the late July bull run and it is clear to see that as Ether (ETH) hiked from $230 to $380, so did its perpetual funding rate. After averaging 1.8% for three weeks, this negatively impacted buyers’ gains.
Again, it might not be harmful for those carrying short-term positions, but it adds up over the months.
To avoid this shortcoming, one might opt for margin trading instead of futures contracts. Borrowing will usually cost between 0.5 and 1.4% per month, while maximum leverage ranges from 3x to 10x.
Similar to the perpetual futures, investors also need to deposit margin to access such markets.
It is worth noting that some exchanges will let users manually pick rates and set periods for borrowing. This method is far superior as it avoids surprises that will naturally occur during heavy buying activity.
While perpetual futures trading is an excellent tool, it comes with shortcomings. Among those, stronger wicks running stop losses, the inability to stake, and the variable funding rate.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should conduct your own research when making a decision.