The Double-Edged Sword of Perpetual Futures: Insights from Crypto Traders

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 expiration date, making them a popular choice among traders. However, the lack of expiry also means that traders must contend with funding rates, which can be a significant expense. To better understand the benefits and drawbacks of perps, we spoke with traders who have thrived in the perpetual futures market. They explained that perps offer deep liquidity, low trading fees, and efficient margin usage, making them an attractive option for both institutional and retail traders. Nevertheless, funding rates are a recurring concern, as they can add up over time and eat into traders' profits. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the 'plumbing underneath everything' his firm does. Outside of bitcoin and ether, dated futures liquidity is limited, making perps the go-to choice for many traders. Kenneth Ong, an independent trader, echoed this sentiment, stating that perps offer better fills, lower fees, and the ability to run both long and short positions simultaneously. Both Krenn and Ong emphasized that margin efficiency is a significant advantage of perps, as they require only a fraction of a position's value as collateral. This allows traders to split their capital across multiple venues and tokens, managing risk more efficiently. Perps have also shifted price discovery, enabling traders to react to news and events in real-time, rather than waiting for markets to open. However, the funding rate remains a significant concern, as it can be unpredictable and difficult to hedge. As Krenn noted, 'It is unquantifiable at the point of trade and unhedgeable afterwards.' Ong was more blunt, stating that funding rates can 'potentially balloon to the point where a profitable trade loses money.' The recent bitcoin bear market highlighted the risks associated with perps, as exchanges socialized losses to protect their systems, resulting in widespread deleveraging. However, Krenn argued that the problem lies not with perps themselves, but with the crypto exchange margin model. He pointed out that dated futures on the same venues face the same issues, and that the key distinction is between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn also offered an interesting insight, suggesting that being long is the structurally safer side, as positive funding is easy to arbitrage away. In contrast, negative funding rates can persist for extended periods, making it difficult for traders to short the underlying token. 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 access, cost savings, and margin efficiency. However, they also come with unique challenges, 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.'