The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' often comes up. These derivatives contracts allow traders to control large positions with minimal capital. Unlike standard futures, perps have no expiration date, making them a popular choice among traders. However, they also come with unique challenges, such as funding rates, which can significantly impact trading costs. To better understand the world of perps, we spoke with traders who have thrived in this market. They explained that perps offer deep liquidity, low trading fees, and efficient margin usage, making them an attractive option for both institutional and retail traders. Nevertheless, the recurring cost of funding rates is a pressing concern, as it can add up over time. So, why do traders prefer perps? The answer lies in their necessity, particularly for altcoins, where dated futures are often illiquid. Perps have become the go-to tool for many crypto-native firms, as they provide a reliable means of trading without the need for replacement contracts. Lucas Krenn, a derivatives trader, noted that perps are the foundation of his firm's operations, allowing them to manage risk efficiently across various venues and tokens. Kenneth Ong, an independent trader, shared a similar perspective, highlighting the benefits of perps for retail traders, including better fills, lower fees, and the ability to run both long and short positions simultaneously. One of the significant advantages of perps is their ability to facilitate price discovery around the clock, rather than being limited to traditional market hours. This has led to a shift in how traders respond to news and market events. However, perps also come with unique challenges, such as the funding rate, which can be a significant burden for traders. Unlike dated futures, which have a fixed interest rate, perps have a funding rate that changes over time and is typically charged every eight hours. This exposes traders to a floating rate, making it difficult to quantify and hedge. As Krenn pointed out, the funding rate can be a substantial cost, especially for long-term positions. Ong shared a similar concern, stating that the funding rate can potentially turn a profitable trade into a loss. The recent bear market has also highlighted the risks associated with perps, particularly the socialization of losses on exchanges. However, Krenn argued that this is not a problem 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 proper clearing houses with mutualized default funds and exchanges that socialize losses onto winners. Krenn also offered 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. In contrast, negative funding rates can persist for extended periods, making it difficult for traders to short the underlying token. This asymmetry is often overlooked in risk models, and funding rates can remain extremely high or low for a long time. In conclusion, perps have democratized futures trading by addressing issues of access, cost, and margin efficiency. Nevertheless, they come with unique pain points, such as volatile funding-rate exposure, which can be difficult to quantify and hedge. As Krenn noted, until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that cannot be priced or hedged.