When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' inevitably arises. These derivatives contracts enable traders to control larger positions with minimal account holdings.
Unlike standard futures, perps have no expiration date, making them a unique and attractive option for traders. However, they also come with distinct challenges, particularly regarding funding rates and liquidity. To better understand the world of perps, we spoke with traders who have thrived in this market, including Lucas Krenn, a derivatives trader at STS Digital, and Kenneth Ong, an independent trader with extensive perps experience.
Their insights shed light on the benefits and drawbacks of perps, including their deep liquidity, low trading fees, and the efficiency of margin usage. One of the primary advantages of perps is their ability to provide traders with better fills, lower fees, and the option to run both long and short positions simultaneously via hedge mode.
This flexibility is particularly beneficial for retail traders, who can execute trades at more favorable prices and manage risk more effectively. Institutional traders also appreciate the margin efficiency of perps, which allows them to manage risk across multiple venues and tokens with greater ease. The perpetual nature of perps has also shifted price discovery, enabling traders to react to news and events in real-time, regardless of traditional market hours.
This has been particularly evident in the tokenized oil trading market, where perps have allowed traders to respond quickly to geopolitical events. Despite these benefits, perps are not without their challenges. The funding rate, which is charged every eight hours, can be a significant concern for traders, as it can fluctuate over time and is difficult to quantify.
This unpredictability can lead to increased costs for traders, particularly those holding positions for extended periods. Furthermore, the lack of a built-in mechanism to lock in funding rates exposes traders to potential losses. The issue of funding rates is further complicated by the fact that it is unquantifiable at the point of trade and unhedgeable afterwards. As Krenn noted, 'It is unquantifiable at the point of trade and unhedgeable afterwards.' Ong also expressed concern about the funding rate, stating that it 'can potentially balloon to the point where a profitable trade loses money.' The recent bitcoin bear market has also highlighted the risks associated with perps, particularly the socialization of losses by exchanges.
However, Krenn argued that this is not a problem inherent to perps, but rather a result of the crypto exchange margin model. The distinction between perpetual and dated futures is not the primary concern; instead, it is the presence of a proper clearing house with a mutualized default fund that matters.
Another important consideration is the asymmetry between long and short positions. Krenn pointed out that being long is structurally safer, as positive funding can be easily arbitraged away. In contrast, negative funding rates can persist for extended periods, making it more challenging for traders to manage risk.
This asymmetry is often overlooked in risk models, and it can have significant implications for traders. In conclusion, perps have democratized futures trading by providing access, cost efficiency, and margin efficiency. However, they also come with unique challenges, particularly regarding funding rates and liquidity.
As the crypto market continues to evolve, it is essential for traders to understand these complexities and develop strategies to mitigate potential risks. Until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that cannot be priced or hedged, making funding a 'tax' that everyone pays for access to this leveraged market.