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 larger positions with minimal capital. Unlike standard futures, perps do not have an expiry date, making them a popular choice among traders. However, their unique characteristics also introduce distinct challenges, particularly with regards to funding rates. To better understand the intricacies of perps, we spoke with seasoned traders who have thrived in this market, including Lucas Krenn, a derivatives trader at 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 trading fees, and efficient margin usage. According to Krenn, perps are the 'plumbing underneath everything' his firm does, as they offer a vital tool for navigating the crypto market. 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. Despite these advantages, traders are also wary of the funding rates associated with perps, which can be volatile and difficult to predict. The funding rate, essentially an interest charge that accrues over time, can become a significant burden for traders who hold positions for extended periods. As Krenn noted, 'it is unquantifiable at the point of trade and unhedgeable afterwards.' Ong was more blunt, stating that 'if you hold positions for long periods, it can potentially balloon to the point where a profitable trade loses money.' The perpetual nature of perps has also shifted the dynamics of price discovery, allowing traders to react to news and events in real-time, rather than being limited to traditional market hours. This has led to increased liquidity and more efficient price discovery, but also introduces new risks and challenges. One of the primary concerns surrounding perps is the issue of liquidations, which can occur when traders are unable to meet their margin requirements. However, Krenn argued that this is not a problem inherent to perps, but rather a result of the crypto exchange margin model. In his view, the key distinction is not between perpetual and dated futures, but rather between exchanges that utilize 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, suggesting that being long is actually the structurally safer side. His logic is that positive funding is easy to arbitrage away, whereas negative funding can persist for extended periods, leading to significant costs for short sellers. Ultimately, perps have democratized futures trading by providing access to a leveraged market with relatively low costs and efficient margin usage. However, they also introduce unique pain points, particularly with regards to funding rate exposure, which can be difficult to quantify and hedge. 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.' In the meantime, funding rates will remain a tax that everyone pays for easy access to this leveraged market.