The Double-Edged Sword of Perpetual Futures: Insights from Crypto Traders

When discussing crypto trading with experienced traders, perpetual futures, or 'perps,' are often the first topic of conversation. These derivatives contracts enable traders to control large positions with minimal capital. Unlike standard futures, perps have no expiration date, making them a unique and attractive option for traders. For altcoin traders, perps are frequently the only viable derivatives market, as dated futures for these assets are often illiquid, and the spot market is not a viable option for those who don't plan to hold. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart from other derivatives and how they cater to the needs of both institutional and retail traders. The traders' responses were unanimous: perps are popular due to their deep liquidity, low trading fees, and high margin efficiency. However, traders are also concerned about the funding rates, which can add up over time. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the foundation of the firm's operations. '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 primary tool.' 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. Ong noted that perps offer a significant advantage over regulated venues like the CME, which typically net positions by default. Both Ong and Krenn emphasized that margin efficiency is the primary draw to perps. With perps, traders can manage risk 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, allowing it to occur whenever news breaks, rather than only during market hours. Ong recalled an instance during the Iran conflict, where tokenized oil trading on Hyperliquid saw a surge in volume over a weekend, while the 'official' market was closed. By Monday, a significant portion of the repricing had already occurred. Krenn sees this mechanism playing out in perps tied to other traditional assets, such as tokenized equities. 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, sidestep these issues and are well-suited for traders who want to trade rather than invest for the long term. Both traders believe that the 'perpification' of various assets will gain momentum in the coming years. Ong noted that tokenized oil trading over the weekend is 'basically a preview' of what's to come for other commodities. As liquidity deepens across commodities and equities, it will become less necessary to use dated futures. However, there is a significant concern among traders: the funding rate. A dated futures contract provides a clear interest rate for the trade, whereas a perpetual futures contract has a funding rate that changes over time, typically charged every eight hours. This exposes traders to a floating rate while holding the position, with no built-in mechanism to lock it in. If the market doesn't move as expected, the funding rate can become a burden. Krenn described it as 'unquantifiable at the point of trade and unhedgeable afterwards.' Ong was more blunt, stating that the funding rate 'is not just some tiny fee you can ignore. It's not. If you hold positions for long periods, it can potentially balloon to the point where a profitable trade loses money.' The issue of funding rates is further complicated by the fact that it is often not priced correctly. Krenn offered an insight that inverts the common assumption about perp risk: being long is structurally safer. His logic is that positive funding is easy to arbitrage away, as anyone holding stablecoins can buy spot and sell the perp, thereby compressing positive funding. However, when the funding rate is negative, the arbitrage involving a long position in the perp and a short position in the spot is more challenging, as it requires shorting the underlying token. This can be difficult, especially if the circulating supply is small and concentrated. As a result, the gap between perp and spot prices can persist, leading to extremely negative funding rates for extended periods. The takeaway is that perps have democratized futures trading by solving issues of access, cost, and margin efficiency. However, they are not without unique challenges, particularly the volatile funding-rate exposure that cannot be quantified while taking bets and cannot be hedged once the trade is on. 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.' For now, funding is the tax everyone pays for easy access to this leveraged market.