When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' often comes up. Perps are derivatives contracts that allow traders to control large positions with minimal capital. They function similarly to standard futures but without an expiry date.
For traders of alternative cryptocurrencies, perps are often the only viable option for derivatives trading, as dated futures contracts for these assets are typically illiquid. Spot markets are also less desirable for traders who don't plan to hold their assets long-term.
To better understand perps, we spoke with traders who have successfully navigated the perpetual futures market. They explained how perps differ from other derivatives, how they meet the needs of institutional and retail traders, and the costs associated with perps trading. The traders we spoke with overwhelmingly agreed that perps are attractive due to their deep liquidity, low trading fees, and efficient margin management. However, they also expressed concerns about funding rates, which are recurring costs for maintaining open positions.
Funding rates can be thought of as interest charges that accumulate over time. Lucas Krenn, a derivatives trader at STS Digital, and Kenneth Ong, an independent trader, both emphasized the importance of perps in the crypto market. Krenn noted that perps are the primary tool for crypto-native firms, as dated futures contracts are often too illiquid to be useful. Ong highlighted the benefits of perps for retail traders, including better trade execution, lower fees, and the ability to hold both long and short positions simultaneously.
Both traders agreed that margin efficiency is a major advantage of perps, as they allow traders to manage risk across multiple venues and assets with minimal capital. The perpetual nature of perps has also shifted the way price discovery occurs, with traders reacting to news and events outside of traditional market hours. This has led to increased liquidity and more efficient price discovery.
Despite the benefits of perps, traders are concerned about funding rates, which can be difficult to quantify and hedge. A funding rate is a charge that is applied to open positions at regular intervals, typically every eight hours. This rate can be volatile and may become a significant burden for traders who hold positions for extended periods.
Krenn and Ong warned that funding rates can potentially turn profitable trades into losses if not managed properly. The traders also discussed the risks associated with perps, including liquidations and the socialization of losses on crypto exchanges.
Krenn argued that these risks are not unique to perps and can be mitigated with proper risk management and the use of clearinghouses with mutualized default funds. In conclusion, perps have democratized futures trading by providing access to leveraged markets with low costs and efficient margin management. However, they also introduce unique challenges, such as funding rate exposure, which can be difficult to quantify and hedge.
As the crypto market continues to evolve, it is essential for traders to understand the benefits and risks of perps and to develop strategies for managing these risks effectively.