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

When discussing crypto trading with seasoned traders, perpetual futures, or 'perps,' are often the first topic of conversation. These derivatives contracts allow traders to control larger positions with less capital, but they also come with unique challenges. To understand what makes perps different from other derivatives and how they cater to the needs of institutional and retail traders, we spoke with experienced traders who have thrived in the perps market. Their responses highlighted the advantages of perps, including deep liquidity, low trading fees, and high margin efficiency, which enables traders to manage risk effectively. However, they also expressed concerns about funding rates, a recurring cost associated with keeping positions open. Funding rates can be thought of as an interest charge that accrues over time, and traders are worried about the potential impact on their profitability. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at market-making firm 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 tool for many traders. Kenneth Ong, an independent trader, echoed this sentiment, citing better fills, lower fees, and the ability to run both long and short positions simultaneously via hedge mode as key benefits of perps. Both traders emphasized that margin efficiency is the primary draw of perps, allowing them to manage risk efficiently across different venues and tokens. Perps also facilitate price discovery, enabling traders to react to news and events in real-time, rather than waiting for traditional markets to open. However, the funding rate remains a significant concern, as it can be volatile and difficult to quantify. Traders are exposed to this risk while holding positions, and it can become a substantial burden if the market doesn't move as expected. The funding rate is typically charged every eight hours and can be a significant expense for traders who hold positions for extended periods. In addition to funding rates, traders also face the risk of liquidations, which can result in significant losses. The October 10 crash last year triggered widespread deleveraging, and profitable shorts were force-closed due to the exchange's insurance fund being depleted. However, Krenn argued that this was not a problem with perps themselves, but rather a crypto exchange margin model issue. The key distinction, according to Krenn, is between facing a proper clearing house with a mutualized default fund and an exchange that socializes losses onto winners. Krenn also offered an interesting insight into 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, but negative funding can persist due to constraints on shorting the underlying token. This asymmetry can result in funding rates staying extremely negative for long periods, making the long side have a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost. In conclusion, perps have democratized futures trading by solving issues of access, cost, and margin efficiency, but they also come with unique pain points, such as volatile funding-rate exposure. 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.'