The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' inevitably arises. These derivatives contracts allow traders to control larger positions with less capital, and they have become a staple in the crypto market. Unlike traditional futures, perps do not have an expiration date, making them a unique and attractive option for traders. However, they also come with their own set of challenges, particularly when it comes to funding rates. To better understand the world of perps, CoinDesk spoke with traders who have thrived in this market, including Lucas Krenn, a derivatives trader at market-making firm STS Digital, and Kenneth Ong, an independent trader with extensive experience in perps. Both traders emphasized the importance of perps in the crypto market, citing their deep liquidity, low fees, and high margin efficiency. According to Krenn, perps are not just one tool among many, but rather the primary instrument for crypto-native firms. Ong, on the other hand, highlighted the benefits of perps for retail traders, including better fills, lower fees, and the ability to run both long and short positions simultaneously. One of the primary advantages of perps is their ability to provide efficient price discovery. Because perps are always 'on,' they allow traders to react to news and events in real-time, rather than being limited to traditional market hours. This has led to a shift in the way traders approach the market, with many now relying on perps to make informed decisions. However, perps also come with unique challenges, particularly when it comes to funding rates. Funding rates are essentially interest charges that traders pay to hold positions open, and they can be volatile and unpredictable. According to Krenn and Ong, funding rates are a major concern for traders, as they can significantly impact the profitability of a trade. In fact, Krenn noted that the funding rate is often more of a concern than liquidations, which are frequently cited as a major risk in perps. The issue with funding rates is that they are unquantifiable at the point of trade and unhedgeable afterwards. This means that traders are exposed to a floating rate while holding a position, with no built-in mechanism to lock it in. If the market doesn't move as expected, the funding rate can become a significant burden, potentially turning a profitable trade into a loss. Ong emphasized that funding rates are not just a minor fee, but rather a significant cost that can 'potentially balloon to the point where a profitable trade loses money.' Despite these challenges, perps remain a popular choice among traders. According to Krenn, the key distinction is not between perpetual and dated futures, but rather between exchanges that use a proper clearing house with a mutualized default fund and those that socialize losses onto winners. Krenn also offered an interesting insight into the asymmetry of perp risk, noting that being long is often the structurally safer side. This is because positive funding is easy to arbitrage away, whereas negative funding can persist for long stretches due to constrained arbitrage. As a result, the long side has a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost. This asymmetry is often overlooked in risk models, and it can have significant implications for traders. In conclusion, perps have democratized futures trading by providing a low-cost and efficient way to access the market. However, they also come with unique challenges, particularly when it comes to funding rates. As Krenn noted, '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.