The Double-Edged Sword of Perpetual Futures: Benefits and Drawbacks According to Crypto Traders

Discussing crypto trading with experienced traders often leads to a conversation about 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, making them a unique and popular choice among traders. For altcoin traders, 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 mostly used for long-term holdings. Traders who have thrived in the perpetual futures market attribute their success to the deep liquidity, low trading fees, and efficient margin usage that perps offer. However, they also express concerns about the recurring funding rates, which can add up over time and impact trading costs. The funding rate is essentially an interest charge that accrues as traders hold positions open, and it can be a significant expense for traders. To understand the appeal of perps, it's essential to consider the challenges associated with dated futures contracts. According to Lucas Krenn, a derivatives trader at STS Digital, dated futures liquidity is limited, making perps a necessary tool for crypto-native firms. Krenn explains that the process of replacing dated futures contracts at expiry is costly, which is why futures-based ETFs are often less efficient than spot ETFs. In contrast, perps offer better fills, lower fees, and the ability to run both long and short positions simultaneously. Kenneth Ong, an independent trader, echoes Krenn's sentiments, highlighting the advantages of perps for retail traders. Ong notes that perps provide more favorable execution prices, lower fees, and the ability to hold both long and short positions in the same account. The hedge mode in perps allows traders to treat these positions as separate entities, rather than netting them against each other. This flexibility is a significant advantage over traditional futures contracts, which often require netting. Both Krenn and Ong emphasize that margin efficiency is a crucial factor in the appeal 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. This enables traders to split their capital across multiple venues and still maintain meaningful positions. The perpetual nature of perps has also shifted the dynamics of price discovery. Unlike traditional markets, which are limited to specific trading hours, perps allow for price discovery to occur around the clock. Ong recalls an instance during the Iran conflict, where tokenized oil trading on Hyperliquid saw a significant surge in volume over a weekend. By the time traditional markets opened, a substantial portion of the repricing had already occurred. Krenn sees a similar mechanism at play in perps tied to other traditional assets, such as tokenized equities. He notes that building a proper tokenized equity product is challenging, as it requires recreating the full legal, operational, and regulatory machinery of traditional share ownership on-chain. Perps, on the other hand, offer a more straightforward solution for traders looking to trade rather than invest for the long term. As the use of perps continues to gain momentum, traders are becoming increasingly aware of the potential risks associated with funding rates. While liquidations are a common concern, Krenn and Ong believe that funding rates pose a more significant threat. 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 while holding positions, with no built-in mechanism to lock it in. If the market doesn't move as expected, the funding rate can become a substantial burden. Krenn and Ong warn that funding rates can be unquantifiable at the point of trade and unhedgeable afterwards, making them a significant concern for traders. The issue of funding rates is further complicated by the fact that they can be volatile and difficult to predict. As Krenn notes, the funding rate can be a tax that everyone pays for easy access to the leveraged market. In conclusion, perps have democratized futures trading by providing a solution to the problems of access, cost, and margin efficiency. However, they are not without unique challenges, particularly the volatile funding-rate exposure that can't be quantified while taking bets and can't be hedged once the trade is on. As the market continues to evolve, it's essential for traders to be aware of these risks and to develop strategies to mitigate them.