The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, perpetual futures, or 'perps,' are often the first topic that comes up. These derivatives contracts allow traders to control large positions with minimal capital. Unlike standard futures, perps do not have an expiry date, making them a unique and attractive option for traders. However, they also come with their own set of challenges, particularly regarding funding rates. To better understand the world of perps, we spoke with seasoned traders who have thrived in this market. They explained what sets perps apart from other derivatives, how they cater to the needs of both institutional and retail traders, and the costs associated with perps trading. The traders we spoke with praised perps for their deep liquidity, low trading fees, and efficient margin usage, which enables them to manage risk effectively. Nonetheless, they also expressed concerns about the funding rates, a recurring cost for maintaining open positions. The funding rate can be thought of as an interest charge that accumulates over time, and traders are worried about its potential impact on their profits. So, why do traders prefer perps? The answer lies in their necessity, particularly for altcoins, where dated futures are often illiquid. According to Lucas Krenn, a derivatives trader at STS Digital, perps are the primary tool for crypto-native firms, as they offer better fills, lower fees, and the ability to run both long and short positions simultaneously. Kenneth Ong, an independent trader, echoed Krenn's sentiments, highlighting the advantages of perps, including their ability to provide hedge mode, which allows traders to hold both bullish and bearish bets on the same token. Both traders emphasized that margin efficiency is a significant draw to perps, as they require only a fraction of the position's value as collateral, enabling traders to split their capital across multiple venues and tokens. The perpetual nature of perps has also shifted price discovery, allowing it to occur at any time, not just when markets are open. However, this has also led to concerns about the funding rate, which can be a significant burden for traders. The funding rate is a floating rate that changes over time and is typically charged every eight hours. This exposes traders to unpredictable costs, making it challenging to quantify and hedge. As Krenn noted, the funding rate is 'unquantifiable at the point of trade and unhedgeable afterwards.' Ong was more direct, stating that the funding rate 'can potentially balloon to the point where a profitable trade loses money.' The traders also discussed the myth of the safe trade, highlighting the risks associated with perps, particularly during times of market volatility. Krenn argued that the problem lies not with perps themselves but with the crypto exchange margin model. He emphasized that the key distinction is between facing a proper clearing house with a mutualized default fund and an exchange that socializes losses onto winners. Krenn also offered an insightful perspective on the asymmetry of perp risk, suggesting that being long is the structurally safer side. His logic is that positive funding is easy to arbitrage away, whereas negative funding is more challenging to compress. This asymmetry can lead to funding rates staying extremely high or low for extended periods. In conclusion, perps have democratized futures trading by addressing issues of access, cost, and margin efficiency. However, they also come with unique pain points, particularly the volatile funding-rate exposure that cannot be quantified or hedged. 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.'