The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the conversation often revolves around perpetual futures, or 'perps' - a type of derivatives contract that enables traders to control large positions with minimal capital. Unlike traditional futures, perps do not have an expiration date, making them a popular choice among traders. However, they also come with unique challenges, particularly regarding funding rates. To better understand the appeal and drawbacks of perps, we spoke with traders who have thrived in this market. Their responses highlighted the advantages of perps, including deep liquidity, low trading fees, and efficient margin usage. Nevertheless, they also expressed concerns about the funding rates, which can add up over time and impact trading profitability. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the foundation of their trading activities, especially for altcoins, where dated futures are often illiquid. Kenneth Ong, an independent trader, echoed this sentiment, citing better fills, lower fees, and the ability to run both long and short positions simultaneously as key benefits of perps. Both traders emphasized that margin efficiency is a significant draw, allowing them to manage risk across various venues and tokens. The perpetual nature of perps has also shifted price discovery, enabling traders to react to news and events outside traditional market hours. This has been particularly notable in tokenized oil trading, where perps have facilitated rapid price adjustments. While perps offer many advantages, they also come with unique challenges. The funding rate, which is charged every eight hours, can be a significant burden, especially for long-term positions. As Krenn noted, this rate is 'unquantifiable at the point of trade and unhedgeable afterwards,' making it difficult for traders to anticipate and manage their costs. Ong warned that ignoring funding rates can lead to significant losses, even for profitable trades. The recent bear market has also highlighted the risks associated with perps, particularly during times of high market volatility. The forced closure of positions, including profitable ones, has led to criticism of perps. However, Krenn argued that this is not a problem with perps themselves, but rather with the crypto exchange margin model. He emphasized that the key distinction is not between perpetual and dated futures, but between exchanges with proper clearing houses and those that socialize losses onto winners. Krenn also offered an insightful perspective on the asymmetry of perp risk, suggesting that being long is structurally safer due to the ease of arbitraging away positive funding. In contrast, negative funding rates can persist, making it more difficult for traders to short the underlying token. This asymmetry is often overlooked in risk models, leading to unexpected outcomes. As the crypto market continues to evolve, perps are likely to play an increasingly important role in futures trading. While they offer many benefits, traders must be aware of the unique challenges and risks associated with these contracts. 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.' For now, funding rates remain the 'tax' that everyone pays for access to this leveraged market.