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

When discussing crypto trading with experienced traders, perpetual futures, or 'perps,' are often the first topic that comes up. These derivatives contracts allow traders to control large positions with minimal capital, and their popularity stems from their unique advantages over traditional futures. Unlike standard futures, perps do not have an expiry date, making them an attractive option for traders. For altcoin traders, perps are often the only viable derivatives market, as dated futures for these assets are typically illiquid. The spot market, on the other hand, is mostly used for long-term holdings. Traders who have thrived in the perpetual futures market cite their deep liquidity, low trading fees, and efficient margin usage as key benefits. However, they also express concerns over funding rates, which can add up quickly and eat into profits. Funding rates are essentially interest charges that accrue over time, and traders are exposed to these rates as long as they hold positions. Lucas Krenn, a derivatives trader, and Kenneth Ong, an independent trader, both emphasize the importance of perps in their trading strategies. Krenn notes that perps are the 'plumbing underneath everything' his firm does, while Ong highlights their ability to offer better fills, lower fees, and the flexibility to hold both long and short positions simultaneously. The perpetual nature of perps allows for price discovery to occur around the clock, rather than being limited to traditional market hours. This has led to increased trading activity in crypto perps, with daily volumes exceeding $200 billion. However, traders also caution about the risks associated with perps, particularly the funding rate. Unlike dated futures, which have a fixed interest rate, perps have a funding rate that changes over time and can be difficult to quantify. This exposes traders to potential losses if the market does not move in their favor. The funding rate can be a significant burden, especially for traders who hold positions for extended periods. As Krenn puts it, 'it is unquantifiable at the point of trade and unhedgeable afterwards.' Ong is 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 recent bear market has also highlighted the risks of perps, with widespread deleveraging and liquidations occurring across the market. However, Krenn argues that the problem lies not with perps themselves, but with the crypto exchange margin model. He notes that dated futures on the same venues face the same issues, and that the key distinction is between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn also offers an interesting insight into the asymmetry of perp risk, suggesting that being long is the structurally safer side. This is because positive funding is easy to arbitrage away, while negative funding can persist for extended periods due to constrained arbitrage. As the crypto market continues to evolve, perps are likely to remain a popular choice for traders. However, it is essential for traders to be aware of the unique risks associated with these contracts, particularly the funding rate. Until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that cannot be priced or hedged. In the meantime, funding will remain the tax everyone pays for easy access to this leveraged market.