The Double-Edged Sword of Perpetual Futures: Weighing the Pros and Cons

When discussing crypto trading with experienced traders, the conversation often revolves around perpetual futures, or 'perps' - a type of derivatives contract that enables traders to control larger positions with less capital. Unlike standard futures, perps do not have an expiration 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. The spot market, on the other hand, is often an afterthought for traders who do not plan to hold onto their assets long-term. To understand the appeal of perps, we spoke with traders who have thrived in the perpetual futures market. They highlighted the deep liquidity, low trading fees, and efficient margin usage as the primary advantages of perps. However, traders also expressed concerns about the funding rates, which can add up over time and eat into their profits. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the 'plumbing underneath everything' his firm does. 'Outside of bitcoin and ether, dated futures liquidity is thin to the point of being unusable,' he explained. 'Perps are not just one tool among several; for a crypto-native firm, they are the tool.' Dated futures contracts are not popular due to the costs associated with replacing them at expiry, which can be expensive. Perps, on the other hand, offer better liquidity, allowing traders to buy and sell large quantities without significantly affecting the market price. Kenneth Ong, an independent trader, echoed Krenn's sentiments, highlighting the benefits of perps for retail traders. 'Perps offer better fills, lower fees, and the ability to run both long and short positions simultaneously,' he said. This is particularly advantageous compared to regulated venues like the CME, which typically net positions by default. Ong started trading in the spot market but eventually shifted to perps due to their superior margin efficiency. Both Ong and Krenn emphasized that margin efficiency is the primary draw of perps. With perps, traders can manage risk more efficiently across different venues and tokens, as they require only a fraction of the position's value as collateral. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than just during market hours. Ong recalled an instance during the Iran conflict, where tokenized oil trading on Hyperliquid saw a significant surge in volume over a weekend. 'The real reaction happened on crypto/tokenized commodity perps while the official market was closed,' he said. Krenn sees the same mechanism playing out in perps tied to other traditional assets. Building a proper tokenized equity product is challenging, but perps can sidestep these complexities, making them an attractive option for traders. Both traders believe that the 'perpification' of various assets will gain momentum in the coming years. However, they also warned about the funding rate, which can be a significant burden for traders. Unlike dated futures contracts, 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. 'It's unquantifiable at the point of trade and unhedgeable afterwards,' Krenn said. Ong was more blunt, stating that the funding rate 'can potentially balloon to the point where a profitable trade loses money.' The recent bear market in bitcoin, which kicked off with a crash on October 10, highlighted the risks associated with perps. Exchanges socialized losses to protect their systems, resulting in the liquidation of both losing and profitable positions. Krenn argued that the problem was not with perps themselves, but rather with the crypto exchange margin model. 'It's not a perpetual problem; it's a crypto exchange margin model problem,' he said. The distinction between perpetual and dated futures is not as relevant as the difference between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn offered an interesting insight into the risk associated with perps, suggesting that being long is the structurally safer side. His logic is that positive funding is easy to arbitrage away, but negative funding is more challenging to address. This creates an asymmetry that few risk models account for. In conclusion, perps have democratized futures trading by solving issues of access, cost, and margin efficiency. However, they are not without unique pain points, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn put it, 'Until there is a liquid dated curve in crypto, the whole market is carrying an interest rate exposure it cannot price and cannot hedge.'