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 comes up. These derivatives contracts enable traders to control large positions with minimal capital. Unlike standard futures, perps have no expiration date, making them a popular choice among traders. For altcoin traders, perps are often the only viable option for derivatives trading, as dated futures for these coins are typically illiquid. The spot market, on the other hand, is usually only considered for long-term holdings. To understand the appeal of perps, we spoke with traders who have thrived in this market. They highlighted the deep liquidity, low trading fees, and efficient margin usage as key benefits. However, they also expressed concerns about funding rates, which can add up over time. Funding rates are essentially interest charges that accrue the longer a position is held. Lucas Krenn, a derivatives trader at STS Digital, explained that perps are the backbone of his firm's operations. 'Outside of bitcoin and ether, dated futures liquidity is thin to the point of being unusable,' he said. 'Perps are not just one tool among many; for a crypto-native firm, they are the primary tool.' Kenneth Ong, an independent trader, shared a similar perspective, citing better fills, lower fees, and the ability to run both long and short positions simultaneously as advantages of perps. Both traders emphasized that margin efficiency is a major draw for perps, as they allow for greater leverage and more efficient risk management. The perpetual nature of perps has also shifted price discovery to a 24/7 process, rather than being limited to traditional market hours. This has led to more efficient price discovery, as traders can react to news and events in real-time. However, the funding rate remains a concern, as it can be difficult to quantify and hedge. Krenn noted that the funding rate is 'unquantifiable at the point of trade and unhedgeable afterwards.' Ong warned 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,' citing the example of the October 10 crash, which triggered widespread deleveraging across both losing and profitable positions. Krenn argued that the problem was not 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 rather between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn also offered an insight that challenges conventional wisdom about perp risk, suggesting that being long is the structurally safer side. He explained that positive funding is easy to arbitrage away, but negative funding can persist due to constrained arbitrage. This asymmetry is often overlooked in risk models, and it 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 introduce unique challenges, 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.' For now, funding remains the 'tax' that everyone pays for easy access to this leveraged market.