Engaging in discussions about crypto trading with experienced traders often leads to conversations about perpetual futures, or 'perps'. These derivatives contracts enable traders to control larger positions with less capital. Unlike standard futures, perps do not have an expiration date, making them a unique and attractive option for traders. For traders of alternative cryptocurrencies, perps are often the only viable avenue for derivatives trading, as dated futures for these assets are typically illiquid.
The spot market, on the other hand, is often an afterthought for traders who do not plan to hold onto their assets long-term. Traders who have thrived in the perpetual futures market highlight the deep liquidity, low trading fees, and efficient margin usage as key advantages of perps. However, they also express concerns about the funding rates, which can add up over time and impact trading costs. Funding rates are essentially interest charges that accrue the longer a position is held, and traders are worried about the potential burden of these costs.
The popularity of perps can be attributed to their necessity, particularly for traders of alternative cryptocurrencies. Lucas Krenn, a derivatives trader, notes that perps are the primary tool for crypto-native firms, as dated futures lack liquidity and are often replaced with new contracts at expiry, incurring additional costs.
Kenneth Ong, an independent trader, echoes this sentiment, highlighting the benefits of perps for retail traders, including better fills, lower fees, and the ability to run both long and short positions simultaneously. Both traders emphasize the importance of margin efficiency in perps, which allows for greater leverage and more efficient risk management.
The perpetual nature of perps has also shifted price discovery, enabling traders to react to news and events in real-time, rather than waiting for traditional market hours. However, this has also led to concerns about the funding rate, which can be volatile and difficult to quantify. Traders are exposed to this floating rate while holding positions, and it can become a significant burden if the market does not move as expected.
The funding rate is typically charged every eight hours and can be a significant cost for traders who hold positions for extended periods. The lack of a built-in mechanism to lock in the funding rate makes it challenging for traders to manage this risk.
Ong warns that the funding rate is not a minor fee that can be ignored, as it can potentially balloon and turn a profitable trade into a loss. The recent bear market in bitcoin has also highlighted the risks associated with perps, particularly the socialization of losses by exchanges. However, Krenn argues that this is not a problem with perps themselves, but rather with the crypto exchange margin model. He notes that dated futures on the same venues face the same issues with insurance funds and deleveraging queues.
Krenn also offers an interesting insight into the asymmetry of perp risk, suggesting that being long is structurally safer due to the ease of arbitraging away positive funding. However, when the funding rate is negative, the arbitrage becomes more complex, and the gap between perp and spot prices can persist. This asymmetry is often not accounted for in risk models, and it can lead to significant costs for traders who are short.
In conclusion, perps have democratized futures trading by providing access, cost-effectiveness, and margin efficiency. However, they also come with unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn puts it, the whole market is carrying an interest rate exposure that it cannot price or hedge, making funding a tax that everyone pays for easy access to this leveraged market.