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

When discussing crypto trading, perpetual futures, or 'perps,' are a dominant topic among traders. These derivatives contracts allow for larger positions with less capital, offering an advantage over standard futures due to their lack of expiry. For traders of alternative cryptocurrencies, perps are often the primary derivatives option, given the illiquidity of dated futures and the spot market's limitations for non-long-term holders. To understand what makes perps unique and how they serve both institutional and retail traders, insights from thriving perps traders were gathered. The consensus is clear: perps are favored for their deep liquidity, low trading fees, and superior margin efficiency, which enables greater trading exposure with less collateral. However, traders also highlighted a significant concern - the funding rate, a recurring cost for maintaining open positions that can accumulate over time. The reason perps see such high daily volumes, exceeding $200 billion, is not by choice but by necessity, especially for assets other than bitcoin and ether, where dated futures lack liquidity. Lucas Krenn, a derivatives trader, and Kenneth Ong, an independent trader, both emphasized the importance of perps in their trading strategies, citing better fills, lower fees, and the ability to hedge positions simultaneously. They noted that the leverage perps offer is significantly greater than standard futures, allowing for efficient risk management across different venues and tokens. The perpetual nature of these contracts has also shifted price discovery, making it possible for markets to react to news in real-time, rather than waiting for traditional market hours. Despite these advantages, both traders expressed concern over the funding rate, which can become a substantial burden if not managed properly, especially for long-held positions. The funding rate's unpredictability and the inability to hedge against it once a trade is open pose significant risks. The traders also addressed the misconception that perps are inherently risky, pointing out that issues such as liquidations are more related to exchange margin models than to perps themselves. An interesting insight provided was that being long is structurally safer due to the ease of arbitraging away positive funding, whereas negative funding rates can persist due to constrained arbitrage, leading to an asymmetry that few risk models account for. In conclusion, while perps have democratized access to futures trading by solving issues of access, cost, and margin efficiency, they introduce unique challenges, notably the volatile and unpredictable funding rate exposure. Until a liquid dated curve in crypto emerges, the market will continue to grapple with unquantifiable and unhedgeable interest rate exposures, making funding a 'tax' for participating in this leveraged market.